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Verint Systems Inc (VRNT) Q2 2019 Earnings Call Transcript

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Verint Systems Inc (NASDAQ: VRNT)
Q2 2019 Earnings Call
Sep 4, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to Verint Systems Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference may be recorded. I would now like to introduce your host for today's conference, Mr. Alan Roden, Senior Vice President of Corporate Development. You may begin.

Alan Roden -- Senior Vice President, Corporate Development and Investor Relations

Thank you, operator. Good afternoon, everyone, and thank you for joining our conference call today. I'm here with Dan Bodner, Verint's CEO; and Doug Robinson, Verint's CFO.

Before getting started, I'd like to mention that accompanying our call today is a WebEx with slides. If you'd like to view these slides in real time during the call, please visit the IR section of our website at verint.com, click on the Investor Relations tab, click on the webcast link and select today's conference call. I'd also like to mention to draw your attention to the fact that certain matters discussed in this call may contain forward-looking statements within the meaning of the Private Security Litigation Reform Act of 1995, and other provisions of the federal securities laws. These forward-looking statements are based on management's current expectations and are not guarantees of future performance. Actual results could differ materially from those expressed in or implied by the forward-looking statements. The forward-looking statements are made as of the date of this call and except as required by law, Verint assumes no obligation to update or revise them. Investors are cautioned not to place undue reliance on these forward-looking statements. For more detailed discussion, how these and other risk and uncertainties could cause Verint's actual results to differ materially and those indicated in the forward-looking statements, please see our Form 10-K for the fiscal year ended January 31st, 2019, and other filings we make with the SEC.

The financial measures discussed today include non-GAAP measures, as we believe investors focus on those measures in comparing results between periods and among our peer companies. Our financial outlook and targets are provided only on a non-GAAP basis. Please see today's WebEx slides or earnings release in the Investor Relations section of our website at verint.com for a reconciliation of non-GAAP financial measures to GAAP measures. Non-GAAP financial information should not be considered in isolation from, as a substitute for or superior to GAAP financial information, but is included because management believes it provides meaningful supplemental information regarding our operating results when assessing our business and is useful to investors for informational and comparative purposes. The non-GAAP financial measures that Company uses have limitations and may differ from those used by other companies.

Now, I'd like to turn the call over to Dan. Dan?

Dan Bodner -- President, Chief Executive Officer and Chairman of the Board of Directors

Thank you, Alan. Good afternoon, everyone, and thank you for joining us today to review our second quarter and first half results. Q2 revenue came in at $324 million on a GAAP basis and $331 million on a non-GAAP basis. Excluding the impact of currency, non-GAAP revenue came in at $335 million, reflecting 8.6% year-over-year growth on a constant-currency basis. Q2 EPS came in at $0.16 on a GAAP basis and $0.82 on a non-GAAP basis. To understand how we're tracking against our annual targets, I would like to start by reviewing our first half results followed by a discussion of our two segments.

Looking at our consolidated first half results, we are pleased to report double-digit revenue growth on a non-GAAP constant-currency basis. In the first half, revenue increased 7.4% on a GAAP basis, 9.2% on a non-GAAP basis, and 10.6% on a non-GAAP constant-currency basis. In addition to strong revenue growth, we increased non-GAAP EPS 20% year-over-year, consistent with our goal of growing earnings faster than revenue.

We're also pleased to report that we are making very good progress on two key strategic initiatives that we have discussed on prior calls, our Cloud First strategy in customer engagement and our software model strategy in cyber intelligence. I would like to review our progress in more detail by segments. In Customer Engagement, we're helping customers to address a very important challenge, reducing their operating costs while elevating the customer experience. Our strategy is to help customers simplify, automate and modernize their customer engagement operations. We help them simplify operations by decoupling the value-add software applications from the communications infrastructure. We help them automate processes by infusing artificial intelligence throughout our portfolio. And we help them modernize their cloud operations by making the cloud migration seamless.

Today, I would like to focus on reviewing our strong clouds momentum. At the beginning of the year, we discussed our Cloud First strategy and provided long-term cloud targets. Customers have responded well to our Cloud initiatives and we are seeing the benefits of our Cloud First strategy in our results.

In the first half of the year, Customer Engagement's GAAP revenue increased 8.1%. On a non-GAAP revenue, Customer Engagement revenue increased 10.8% and more than 12% on a constant-currency basis. We're pleased with the first half double-digit growth which is in line with our annual guidance for this segment. From a mix perspective, in the first half, cloud represented 25% of our non-GAAP revenue, up from 19% in the first half of last year. Recurring revenue, which includes both cloud and maintenance, represented 62% of our non-GAAP revenue, up from 59% in the first half last year. We're encouraged by the pace of the mix shift, while at the same time achieving double-digit revenue growth.

Now, let's look at our cloud trends more closely. In the first half of the year, our non-GAAP cloud revenue increased 49% year-over-year, with SaaS revenue growing a bit faster. We see improved market adoption with more large customers embracing cloud deployments. We've seen this trend manifest itself in two ways. First, new cloud deployments, where customers choose to deploy new software in the Verint cloud. And second, conversion of customers existing on-premises deployments to the Verint cloud.

On past calls, we reviewed the opportunity to convert our installed base with an uplift of at least 2x of maintenance revenue. We also discussed the expectations that the uplift would begin to contribute significantly to our revenue growth over the next three years, as more of our large installed base moves to the Verint cloud.

During the first half, we had several customers convert from maintenance to the Verint cloud, and while early, we are pleased to report that the terms of those deals validated the opportunity for a 2x uplift.

To better understand cloud growth, we would like to share ACV data for new SaaS contracts received within the period. In the first half of the year, new SaaS ACV increased 84% year-over-year. And the last 12 months, new SaaS ACV increased 95% year-over-year. As we look forward, we expect new SaaS ACV to increase more than 80% for the full year. In addition to ACV growth, we're also pleased to report an increase in the number of cloud deals with TCV of over $1 million, which reflects a higher level of interest in cloud for larger enterprises. In the first half, we had 11 cloud deals with a TCV greater than $1 million compared to only four in the first half of last year. The average cloud contract duration approached 2.5 years, a bit longer than the average last year.

The large cloud deals were received during the first six months of the year, cut across many different verticals and were [Phonetic] from existing customers as well as new customers, including competitive displacements. With the growing cloud adoption in large enterprises across multiple buyers within the same organization, including in the contact center, customer experience, branch, back office and marketing functions. These support our strategy to help different parts of an organization to collaborate, to drive elevated customer experience, while reducing their operating costs.

Turning to our recent M&A activities. Last quarter, we discussed a buy versus build approach and reviewed the ForeSee acquisition in connection with our strategy to accelerate a voice of the customer roadmap. We discussed ForeSee's low renewal rates at the time of the acquisition and our plan to improve renewal rates with introduction of a new unified VoC platform. A new platform was launched in Q2 and was well received by customers and industry analysts. For example, Ventana Research said, Verint solutions have always been leading-edge, but the unified VoC solution, providing a complete cross-channel view of the customer, is a true innovation. I'm pleased to share that with the progress we made with integration and with the introduction of the new VoC platform ForeSee's renewal rates improved in Q2 from the Q1 level, and we expect continued improvement in the second half.

Moving to a more recent acquisition, at the very end of Q2, we made another technology tuck-in acquisition of an innovative cloud company called Transversal. This is a small company with an annual revenue run rate of around $8 million, breaking even with an impressive technology team. This is another good example of our buy versus build approach. The acquisition is accelerating the roadmap of our machine-learning and artificial intelligence capabilities to better deliver contextual knowledge to both agents and self-service bots.

As previously discussed, going forward, we expect to continue providing financial details and discussing the strategic rationale of our acquisitions, even if immaterial to our results.

In addition to our strong cloud momentum, we continued to execute well on our automation innovation strategy. During the first half, our innovation in machine-learning, artificial intelligence and robotics was widely recognized by industry analysts. For example, Forrester commented in their recent conversational artificial intelligence report, Verint's strong analytics environment stand out from the pack. Also, AI Breakthrough, another industry research firm, recognized Verint for innovation and success in artificial intelligence, machine-learning platforms, smart robotics, analytics and natural language processing.

In summary, we're very pleased with our first half Customer Engagement results, reflecting the successful execution of our simplify, automate and modernize the strategy as well as our commitment to innovation. We saw strong momentum in cloud, driven by improved cloud adoption in the enterprise market and strong execution of our Cloud First strategy.

Turning to Cyber Intelligence. We are a global market leader with a broad portfolio across the cyber intelligence, cyber security and physical security markets. Our advanced data mining solutions help customers capture and analyze structured and unstructured data and gain insights that help accelerate security investigations. In the first six months of the year, Cyber Intelligence revenue increased by more than 6%, about 7.5% on a constant-currency basis. This revenue growth was accomplished by accelerated margin expansion -- sorry, revenue growth was accompanied by accelerated margin expansion, which I will discuss shortly.

In Q2, we continued to win large deals around the world, including an order of approximately $15 million and four orders with an average size of around $5 million each. We believe these types of large orders reflect our ability to address the market -- two trends that we have discussed on past calls. First, security threats are becoming more complex. And as a result, security and intelligence organizations find it more difficult to detect, investigate and neutralize threats and are seeking new data mining solutions. And second, there is a shortage of data scientists and cyber analysts, and security organizations are seeking advanced automation capabilities to perform functions previously performed by humans. With more than 1,000 customers and a large solution portfolio, we are well positioned to benefit from these trends with both existing and new customers. We continue to expand our customer base and also pleased to report that we added approximately 50 new customers in the first half.

Over the last few years, we discussed a strategy to shift from an integrator model to a software model through investments in unbundling and productizing our data mining software. Historically, large deals sold under the integrator model included a fair amount of pass-through hardware and customer development services, and Verint delivered these professional services in addition to deploying our data mining software.

Shifting to a software model, over the last two years, we have made product investments, enabling our customers and third-party integrators to deliver a third-party hardware itself and perform some of the customer developments using our standard APIs. We believe there are significant benefits to our customers from the software productization, making our software easier to implement and easier to refresh, which is critical in a rapidly evolving technology landscape. Customers have realized that the integrator model, which provides them one-stop shop accountability is quite limited in terms of system openness and the ability to quickly deploy software enhancements. The investments we've made in the software model create significant benefits to our customers and improve our competitive differentiation.

During the first half, consistent with our software model strategy, we saw a reduction in the amount of third-party hardware we pass through as well as a reduction in our development services. These reductions came in at a faster pace than originally planned and led to a 6% increase in gross margin year-over-year.

Overall, we're pleased with the execution of our software strategy. And excluding pass-through hardware in both periods, Cyber Intelligence segment revenue increased double digits in the first half of the year.

In summary, we're pleased with our second quarter and first half results and the progress we've made with our two key strategic initiatives. In the first half, we increased non-GAAP revenue double digits on a constant-currency basis, expanded margins, and increased EPS 20% year-over-year. In Customer Engagement, we experienced strong cloud momentum and in Cyber Intelligence, our software model transition progressed ahead of plan.

Now, I would like to turn the call over to Doug to discuss our financial results and outlook in more detail. Doug?

Douglas Robinson -- Chief Financial Officer

Yeah, thanks, Dan. Good afternoon, everyone. Our discussion today will include non-GAAP financial measures. Reconciliation between GAAP and non-GAAP financial measures is available as Alan mentioned in our earnings release and in the IR section of our website. Differences between our GAAP and non-GAAP financial measures include adjustments related to acquisitions, including fair value revenue adjustments, amortization of acquisition-related intangibles, certain other acquisition-related expenses, stock-based compensation, as well as certain other items that can vary significantly in amount in frequency. For certain metrics, it also includes adjustments related to foreign exchange rates.

We're pleased with our strong first half of fiscal '20 and I'll start today by discussing Q2 and first half, and then I'll discuss our outlook. Our Q2 results follow a very strong Q1 and I'll review both our Q2 and the first half results to explain where we stand at the midpoint of the year.

Starting with Q2, non-GAAP revenue came in at a bit over $331 million, a 7% year-over-year increase. On a constant-currency basis, non-GAAP revenue was $335 million, up 9% over last year's second quarter. Non-GAAP diluted EPS was $0.82 for Q2, up 8% year-over-year. Our Q2 revenue reflect an acceleration in our Cyber Intelligence software model plan, which resulted in a reduction in our third-party hardware sales, which I'll discuss later.

During the first half, we achieved strong non-GAAP revenue growth of 9.2% year-over-year and non-GAAP revenue growth on a constant-currency basis was 10.6%. Non-GAAP gross margin expanded 250 basis points to 67.4%, driven by the acceleration of our Cyber Intelligence software model. Non-GAAP operating income increased 17% and non-GAAP operating margins improved by 140 basis points from last year's first half.

Adjusted EBITDA increased 15% as margins expanded by 120 basis points. Non-GAAP diluted EPS increased 20% year-over-year ahead of our annual guidance of 14%.

Now, I'd like to review our Q2 and first half results by segment. In Q2, non-GAAP Customer Engagement revenue increased 8% from last year or 9% on a constant-currency basis. As you look back at our first half results, I'm pleased to report that non-GAAP revenue increased 11%, which was 12% on a constant-currency basis. Non-GAAP recurring revenue increased by nearly 17%. We continued to benefit from high renewal rates for recurring revenue of approximately 90% and strong growth from new contracts.

As Dan mentioned earlier, the mix of our business is fundamentally improving as our non-GAAP recurring revenue represented 62% of total revenue in our Customer Engagement segment during the first half of fiscal '20, an increase from 59% in last year's first half. The key driver was a strong growth in our non-GAAP cloud revenue of nearly 50% year-over-year. Estimated fully allocated non-GAAP gross margins were up 50 basis points as we had targeted. Our estimated fully allocated adjusted EBITDA margins declined a bit from last year, due to the timing of certain expenses. For the year, we expect these margins to be up for the year around 28.5%.

I'd like to make a few comments about the strong momentum we're experiencing with our Cloud First strategy. First, the increase in the number of large deals from enterprise customers is an important data point suggesting that large enterprises are starting to adopt cloud faster. As you may know, enterprises move to the cloud at different paces and we're helping them make this migration easier. For example, we offer solutions with feature parity across on-premise and SaaS, allowing a seamless user transition. The size and breadth of our enterprise customer base provides significant future growth opportunities as we help them execute their individual cloud strategies.

Second, regarding the strong ACV growth, we discussed in prior calls for a while that it has been giving customers quotes for both -- giving customer quotes for both on-premise and SaaS solutions. In the first six months of the year, we saw more customers choosing the SaaS option, as evidenced by more than 80% new SaaS ACV growth. We expect this trend to continue and currently expect around 80% ACV growth for the year as well.

Now let me turn to Cyber Intelligence. In Q2, non-GAAP Cyber Intelligence revenue increased 7% from last year or 8% on a constant-currency basis. As we look back on our Cyber Intelligence segment for the first half of the year, I'm pleased to report that non-GAAP Cyber Intelligence revenue increased 6% year-over-year or 7.5% on a constant-currency basis, while at the same time accelerating our software model plan.

As Dan discussed earlier, over the last two years, we have made product investments, enabling our customers and third-party integrators to deliver third-party hardware themselves and perform some of their customer developments using our standard APIs. During the first half of fiscal '20, we executed well on the software model and saw a significant reduction in the amount of third-party hardware we resell. This reduction came in at a faster pace than really expected and led to a 6% increase in estimated fully allocated gross margin year-over-year ahead of our plan.

Overall, this is an important strategic objective and we are pleased to over achieve in the first half, while driving down our low-margin hardware revenue. As Dan mentioned earlier, excluding pass-through hardware, we experienced double-digit revenue growth in the first half of the year. As we continued our first half investments in our software model strategy, our estimated fully allocated adjusted EBITDA margin increased by 420 basis points, less than our gross margin expansion.

Now turning to the balance sheet. At the end of Q2, we had $466 million of cash and short-term investments, including short-term and long-term restricted cash and investments. We ended the quarter with net debt of $351 million, including long-term restricted cash and investments and excluding discounts and issuance costs primarily associated with our convertible debt.

Year-to-date, cash flow from operations on a GAAP basis was $98 million, down slightly from last year due to the timing of collections and payments. For the full year, we expect cash from operations to increase over last year. Our net debt-to-EBITDA ratio is 1.1, and we're pleased that Moody's upgraded our corporate debt rating to Ba2 during the quarter due to our continued growth and increased profitability.

Turning to our annual guidance. We expect total non-GAAP revenue of $1.375 billion with a range of plus or minus 2%, reflecting just over 10% growth for the year. From an operating margin perspective, we expect non-GAAP operating margins in fiscal '20 of approximately 22%. We expect our non-GAAP quarterly interest and other expense excluding the potential impact of foreign exchange to be approximately $5.6 million. Given volatility in foreign exchange rates, there could be future gains or losses related to balance sheet translations in our future results which are not included in our guidance. We expect our non-GAAP tax rate to be approximately 9% for the year, reflecting the amount of cash taxes we expect to pay this year.

Our cash tax rate is slightly lower than what we were previously guiding to. Based on lower estimated tax payments, we now expect to make [Phonetic] across our various entities. Based on these assumptions and assuming approximately 67.7 million average diluted shares outstanding for the year, we're expecting non-GAAP diluted EPS at the midpoint of our revenue guidance to be approximately $3.65.

In addition to our annual guidance, we'd like to provide you with our current view on how the year will progress. In Q3, we expect non-GAAP revenue to be similar to Q2, which is consistent with past years, followed by our usual seasonally strong Q4. We also expect EPS in Q3 to be similar to Q2.

And this concludes our prepared remarks. So operator, can we please open up the lines for questions?

Questions and Answers:

Operator

Thank you. [Operator Instructions] And our first question comes from Dan Ives with Wedbush Securities. Your line is open.

Daniel Ives -- Wedbush Securities -- Analyst

Yeah, thanks. So, can we just talk about on the cloud, just maybe how the conversations are changing with customers? Now you're starting to see more strategic deals there and Dan and Doug, maybe you can just talk about like how things are changing in the pipeline from a deal flow perspective and maybe just changes there?

Dan Bodner -- President, Chief Executive Officer and Chairman of the Board of Directors

Yeah, we certainly think that there is a clear change, especially at the enterprise level, which is the majority of our business is enterprise focused. And the conversation is changing from just talking about cloud to actually buying SaaS. We've been giving customers quotes both ways for quite some time, giving them the choice to move to the cloud at their own pace. And we see now more enterprise customers are actually choosing [Indecipherable] self process, they're choosing the SaaS option. And I think it's primarily because of the things we've done to make it seamless for them. Doug mentioned feature parity, which is an important consideration for customers who want to move on-prem to cloud, they can maintain the same functionality without retrain users. And it's the overall cloud security that we offer and global deployment that we offer. We have now a pretty scalable cloud operations. We're expecting to finish the year with ARR approaching $250 million. We have several cloud partners and one of the largest partners is AWS and we are one of the top 100 partners of AWS. So we are scaling our infrastructure, which help us also to provide better pricing, better security and make enterprise customers very comfortable with the transition to the cloud.

And the evidence is 11 $1 million deals in H1 versus four in H1 last year, and also longer duration of contract. So these are all the things that show us that the trend is real. And we talked about expectation for 80% growth in new SaaS deals, new SaaS ACV for the year. So we achieved 80% in H1, and we believe we'll achieve 80% for the year.

Daniel Ives -- Wedbush Securities -- Analyst

Thanks. I'll go back in the queue.

Operator

Thank you. And our next question comes from Samad Samana with Jefferies. Your line is open.

Samad Samana -- Jefferies -- Analyst

Hi. Thanks for taking my questions today. Appreciate it. Maybe Dan, one for you first. When you think about the characteristics of the maintenance customers that had moved to SaaS, the early proof points that you have, is there any particular characteristics of those customers? Is there any type of pattern that you're seeing? I know it's a small sample set, but what's leading them to move from maintenance to SaaS early on that you've seen that, that might help you as you think about future conversion opportunities? And I have some follow-up questions.

Dan Bodner -- President, Chief Executive Officer and Chairman of the Board of Directors

Yeah, that's a very good point. So we -- firstly, we're so early, so we have a handful of data points. And the point for us was to continue to validate that the 2x uplift is not only something that we target, but also it provides benefits to our customer. So it's a win-win arrangement where they save a lot of money on their internal data center and internal operations by moving the cloud operation into the Verint cloud. And I think that has been validated.

We also see that customers, as they move on-prem deployment to the cloud, typically also interested in expansion, either expansion of their solution or actually adding more solutions. So it's a good inflection point for us to discuss with the customers, something that is more strategic than just saving some money on changing the deployment to the cloud. We believe that we'll see in the future, the move to the cloud by enterprises as a strategic decision and one that can help us to -- in addition to the uplift to continue our land and expand strategy with these customers.

Samad Samana -- Jefferies -- Analyst

Great. And then, Doug, if I could ask some follow-up questions. So the acquisition of Transversal, I know its immaterial in terms of the overall size, but how should we think about whether that business was growing? And then, if I think about just $8 million, does that imply that the -- that there's $8 million lower in the core guidance? Just maybe help me think about the impact of that and how that's factored into numbers, and [Indecipherable] the company would still be on track on an organic basis to hit the targets that you've set out for the year.

Douglas Robinson -- Chief Financial Officer

Yeah, sure. Transversal is a very small acquisition, it was primarily technology oriented. They had some nice technology, wanted to combine with ours. So, we didn't really looked at that as kind of a run rate continuing business as much as we just wanted the kind of the code to get to book with ours. It's a million or two a quarter, kind of offsetting some of the FX headwind, if you will, so not really additive to Verint overall.

Samad Samana -- Jefferies -- Analyst

Okay, great. And then just one more, if you indulge me. I was just looking at non-GAAP cloud revenue and I think based on the July investor presentation that you guys have put out, I think there is maybe a slight quarter-over-quarter dollar decline from 1Q to 2Q. I'm curious if that was just in the managed services piece or if that was in core SaaS? Maybe I think you can just help us understand how those two pieces looked this quarter as well.

Dan Bodner -- President, Chief Executive Officer and Chairman of the Board of Directors

Yeah. So when you look at cloud revenue growth, the growth comes from a combination of renewal rates of existing accounts and new deals, right? So obviously, we have very strong new deals and we also have strong renewals. We talked about 90% renewal. But you also remember that we discussed that the ForeSee renewals in Q1 were in the 50s. And while we improved them in Q2, they're still well below our average renewal rate as expected. We are working hard on improving the renewal rates in ForeSee, and that's going to come with the introduction of our VoC platform which is going very well. But definitely there is an impact on the sequential growth until we can get the renewal rates to our average. And whether -- and when you look at the new SaaS deals, new SaaS ACV, well, it's growing 80%, we would get 11 $1 million deals, the time between the bookings and the revenue is longer on bigger deals. So that's also a little bit of a lag between the booking and the revenue. So overall, we see the cloud revenue continue to grow in Q3 and Q4. And as I mentioned earlier, we see the year ending with about [Phonetic] 40% growth in revenue. And ARR -- the Q4 ARR will be approaching $250 million.

Samad Samana -- Jefferies -- Analyst

Great. And just one last housekeeping question. So new SaaS ACV, does that include maintenance conversions that contract for SaaS [Indecipherable] new ACV bucket as well?

Dan Bodner -- President, Chief Executive Officer and Chairman of the Board of Directors

Yeah, we do include that because they are new SaaS contracts. But they were, again, a small number so far. They should become a bigger number over time, but they will -- yes, they will be included and they will drive this, hopefully, to a much larger growth rate.

Samad Samana -- Jefferies -- Analyst

Great. Thank you guys for taking my questions. I really appreciate it.

Dan Bodner -- President, Chief Executive Officer and Chairman of the Board of Directors

Sure.

Operator

Thank you. We have a question -- a follow-up from Daniel Ives with Wedbush Securities. Your line is open.

Daniel Ives -- Wedbush Securities -- Analyst

Yeah. Just one last question. Can you maybe just talk about hiring plans on the sales force, just given on the cloud side and maybe some of the hiring plans there? Thanks.

Dan Bodner -- President, Chief Executive Officer and Chairman of the Board of Directors

Yeah. So if you take a closer look at our first half, you can see that our opex investments actually were substantially in H1. This is ahead of growth that we expect in H2. So in terms of hiring and growth and investments, we basically have done that in H1. We believe that's going to drive the growth in H2. The mix between H1 has went through is pretty good. The overall number for Customer Engagement, we did $434 million in the first half. That's a 48.2% of the year, so that's pretty consistent with the 48%, 52% that we had in prior years. So, we think that we are pretty good on the investment we made in H1. And if we consider more investments, it will be toward the end of the year, toward growth next year. But we're not expecting headcount growth in H2.

Daniel Ives -- Wedbush Securities -- Analyst

Great. Thanks.

Operator

Thank you. And our next question comes from Hugh Cunningham with OpCo. Your line is open.

Hugh Cunningham -- OpCo -- Analyst

Hi, guys. Thanks for taking my question. First one is relatively simple. This is just on the Cyber Intelligence side. So, excluding hardware, you're saying revenue there grew double digits, which is very encouraging. And I'm trying to understand what you're seeing in that market. And specifically, what you're seeing in sort of the important markets, emerging markets -- markets leverage to commodities, etc.

Dan Bodner -- President, Chief Executive Officer and Chairman of the Board of Directors

Yes, clear. So let me first just address the hardware. So to be clear, why we are -- why we gave this metric of excluding hardware, that's because we are intentionally driving this hardware pass-through down. This is in the making for a couple of years and we now see acceleration, and we're really happy about it. But it's, obviously, a decline year-over-year. Actually that the number excluding hardware in H1 this year and last year will be 12% growth. So we're happy that the portfolio overall, excluding hardware, is growing 12% in H1.

Now, putting that into perspective of the macro environment, so we clearly hear from customers that the need for advanced data mining solutions is strong. And government agencies across the globe are really looking for new advanced technology to help them combat crime and terror, and the challenges are big and the security threats are increasing and the need for technology is certainly there.

Obviously, your question about emerging markets and so more and so forth is, in order to be able to buy, they need to be able to keep their funding. And there is a changing economic environment that can impact spending. But I can say that at this point, we have not seen any evidence that budget has been negatively impacted across the globe.

Hugh Cunningham -- OpCo -- Analyst

On that same point on Cyber Intelligence, Dan, the -- do you have any sort of sense for, you may have said this, I just forget, where margins can get to in that business if you get hardware revenue down to where you want it? Or how far down can you get it basically?

Dan Bodner -- President, Chief Executive Officer and Chairman of the Board of Directors

Yes, yes, absolutely. So the hardware -- specifically, the hardware was 10% last year and we expect it to be certainly less than 5% on a -- in the long-term model. But in addition to hardware reduction, which we are achieving ahead of plan, we also starting to see the benefits from development services reduction, so that customers that need to develop some customized software, they can do it with APIs, they don't have to ask Verint to do it for them. And that's also another trend of reduction in development services.

So overall, if we look at the last year, 25% of our total revenue in Cyber came from professional services, which includes hardware, include development services and include implementation services, that was 25%. The target we gave -- the three-year target we gave last quarter is that, by fiscal '22, our three-year target, we expect this 25% to come down to 15% of our total revenue. So that's a 10% reduction that will increase the gross margin to about 70%.

So, we see our Cyber business as a growing business with a 70% gross margin software model. We are also starting to see more subscriptions, so the recurring part of the business is growing. And we think these are all very good trends that not only benefit the Verint financial model, but as we discussed, also customers see benefits from being able to buy more standard software and get a much faster refresh cycle that they need in order to keep this of their current.

Hugh Cunningham -- OpCo -- Analyst

Sure. Thank you. One last question on CE, Dan. Just sort of a big picture question. One of the questions we're getting fairly frequently is about what happens if the economy turns down. There's some sort of confusing signs out there in the marketplace right now. Our sense is that with your investments in things like machine-learning and artificial intelligence and this -- your new announcement of this voice of the customer platform, these sort of things sort of decouple you or give you some immunity from a downturn in the macro economy. And in fact, as your customers start to respond to a slowing economy that may generate more business for you. Can you talk about how you look at it?

Dan Bodner -- President, Chief Executive Officer and Chairman of the Board of Directors

Yes. I think that's -- you kind of summed it very well, because our overall existence in Customer Engagement is really to help customers reduce operating costs. This is all we do. Well, we hear from customers that they don't want only to reduce cost, they want to do it while elevating the customer experience or at least not see an erosion in the customer experience. So that's why it has to be with a lot of automation and analytics to make sure that reduction in operating costs does not come at the expense of customer dissatisfaction.

But the focus on cost reduction, what we've seen in the past, when the economy turn down negative was a very strong focus, because customer service is very dependent on people and our estimate is more than $1 trillion of spending in the industry on the workforce. So there is typically a focus on how can we make the workforce more productive, how can we achieve our strategic goal with less cost. And again, just reducing the workforce or shifting the workforce to overseas to low-cost areas has proven not to do the trick. So technology will be more in demand to allow them to reduce costs while achieving their strategic objectives.

Hugh Cunningham -- OpCo -- Analyst

Thanks for taking my questions, and I appreciate it.

Douglas Robinson -- Chief Financial Officer

Sure, Hugh.

Operator

Thank you. And I'm showing no further questions at this time. I'd like to turn the call back to Mr. Alan Roden for any closing remarks.

Alan Roden -- Senior Vice President, Corporate Development and Investor Relations

Thank you, operator, and thanks, everyone, for joining our call tonight. Have a great evening.

Operator

[Operator Closing Remarks].

Duration: 45 minutes

Call participants:

Alan Roden -- Senior Vice President, Corporate Development and Investor Relations

Dan Bodner -- President, Chief Executive Officer and Chairman of the Board of Directors

Douglas Robinson -- Chief Financial Officer

Daniel Ives -- Wedbush Securities -- Analyst

Samad Samana -- Jefferies -- Analyst

Hugh Cunningham -- OpCo -- Analyst

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