Verint Systems (VRNT) Q2 2021 Earnings Call Transcript

Verint Systems (VRNT -2.71%)
Q2 2021 Earnings Call
Sep 09, 2020, 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Verint Systems Inc. second-quarter 2021 earnings conference call. [Operator instructions] It is now my pleasure to introduce Senior VP Corporate Development Alan Roden.

Alan Roden -- Senior Vice President, Corporate Development

Thank you, operator. Good afternoon, 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 slides.

If you would 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 draw your attention to the fact that certain matters discussed on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other provisions of the federal securities laws. These forward-looking statements are based on management's current expectations and are not guarantees of future performance. Actual results could differ materially from those expressed in or implied by these forward-looking statements.

The forward-looking statements are made as of the date of this call, and except as required by law, Verint assumes no obligation to update or revise them. Investors are cautioned not to place undue reliance on these forward-looking statements. For a more detailed discussion of how these and other risks and uncertainties could cause Verint's actual results to differ materially from those indicated in these forward-looking statements, please see our Form 10-K for the fiscal year ended January 31, 2020, 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.

Please see today's WebEx slides, our earnings release and 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 included because management believes it provides meaningful supplemental information regarding our operating results when assessing our business and is useful to investors for informational and comparative purposes. The non-GAAP financial measures the company uses have limitations and may differ from those used by other companies. Now I'd like to turn the call over to Dan.

Dan?

Dan Bodner -- Chief Executive Officer

Thank you, Alan. I'm pleased to report a strong second quarter with sequential revenue growth coming in better than expected. Cash from operations was also strong in Q2, and for the first six months, increased nearly 40% year over year. Looking ahead, our view of the year has improved, and we believe the Q2 cloud momentum will continue in the second half of the year with sequential non-GAAP revenue growth in both Q3 and Q4.

Also, I'm pleased to report that we expect to make an initial confidential submission to the SEC later this month and are on track to complete the separation shortly after fiscal year end. Turning to customer engagement, in Q2, we experienced significant cloud momentum, driven by demand for our analytics, workforce productivity, and compliance solutions in the cloud. We delivered strong performance across cloud revenue and booking metrics as follows. Cloud revenue, excluding ForeSee, increased 28% year over year on a non-GAAP basis.

New SaaS ACV bookings increased 65% year over year and also accelerated sequentially. In Q2, 80% of our non-GAAP software revenue came from recurring sources, compared to 74% in the same quarter in the prior year. As previously discussed, we believe our transition to the cloud will be substantially complete when 85% of our software revenue comes from recurring sources. We are pleased with our progress and are targeting completion of our cloud transition within two years, which Doug will discuss in more detail later.

Finally, I'm pleased to report that despite the COVID impact on our on-premises deals, new perpetual license equivalent bookings increased 3% year over year in Q2, driven by the cloud. Based on what we see now, we believe on-premises deals will come back gradually in the remainder of the year. Combined with sustained cloud momentum, we expect new perpetual license equivalent bookings to improve in the second half of the year and grow mid to high single digits. During Q2, we continued to win new cloud customers and displace competitors due to our strong differentiation in artificial intelligence and automation and our communication infrastructure neutrality.

We won many seven-figure cloud deals across the financial services, government, technology, and healthcare industries. And here are a few examples. A $7 million cloud order for a new global technology customer that made Verint its cloud platform of choice, replacing several foreign solutions providers. We won this large deal because of our best-of-breed cloud platform that can scale to support their growing contact center and back-office operations.

A $3 million cloud order from a long-standing Verint's banking customer that is adopting a cloud platform to benefit from faster innovation and lower total cost of ownership. And a $2 million cloud order from a leading food delivery company to support their rapid growth. This customer chose Verint due to our differentiated workforce management functionality and our open cloud platform that makes it easy to integrate and scale. In addition to these large cloud orders, I'm pleased to report that in Q2, we received an initial multimillion-dollar order for the social security administration, following the appeal process we discussed in prior quarters.

We are now delivering on this initial order, and we expect Verint to receive additional orders for the social security administration as the project advances over time. I would like to take a few minutes to provide COVID updates and discuss the trends we are currently seeing in the customer engagement market. In Q2, we saw certain customers moving forward with on-premises deployment that was previously slowed down due to COVID. In the second half of the year, we expect on-premises deals to continue to pick up gradually.

We believe that certain trends that were already under way prior to COVID will accelerate as a result of the pandemic. The first one is cloud adoption. In that regard, looking at our pipeline, we see a noticeable shift toward the cloud since the beginning of the year. The second trend is the adoption of AI and automation to drive efficiencies and to deliver superior customer experience.

Since our last call, we launched several new AI-based applications, including real-time agent assist. This new AI-based tool provides the workforce with real-time guidance during calls to help improve their productivity and show compliance and drive better customer experience. This new real-time capability is of particular importance during COVID, where employees working from home need tools to guide them through the changing environment. The third trend is the increasing role of partners in our industry.

Our partner agnostic strategy, an open cloud platform, make Verint a unique strategic partner. We are investing in expanding our strong partner network across technology vendors, resellers, and system integrators, and believe this strategy will deliver incremental cloud growth over time. Overall, we believe we are uniquely positioned to address these trends with the cloud platform, AI and automation, fast innovation, and an expanding partner network. In summary, we are on track with our cloud strategy and expect to complete a cloud transition within two years.

As part of our strategy, we will continue to expand our partner program to drive incremental growth. We expect a sequential increase in non-GAAP revenue in Q3 and Q4 as our cloud momentum continues and on-premises deals gradually return. We also expect new perpetual license equivalent bookings to improve and grow in the second half, mid to high single digits year over year. Turning to our cyber business, our analytical security software generates actionable intelligence for many governments and enterprise customers around the world.

In Q2, we received multiple large orders, including two orders for approximately $15 million each, one order for approximately $10 million, and four orders for approximately $4 million each. Customers come to Verint for our mission-critical security software to help prevent terror, crime, and cyber threats and to accelerate investigations. In Q2, we continued to experience demand for analytical security software, and we are working closely with our customers around the world to navigate the current environment to minimize the impact of travel restrictions. Behind these large orders is a broad portfolio of analytical security software.

Our investigative analytics empower national security agencies around the world to apply data science to find the needles in the haystacks, accelerating complex investigations. Our operational intelligence analytics empower these agencies with near real-time actionable insights, a critical factor for field operations to achieve successful missions. And our threat intelligence analytics, empower government and enterprise security customers with actionable intelligence to detect, respond, and mitigate physical and cybersecurity threats. We continue to win large deals every quarter due to our innovation in Big Data fusion, AI and analytics engines, data visualization, and data governance.

And we continue to invest in an open platform to drive down professional services and to allow customers and third parties to manage and enhance the solution on their own. Over the last few years, we've transitioned from a system integrator model in which we performed integration professional services to a software model in which we sell open software solutions. We believe our software model is resonating well with customers because they benefit from faster software refresh cycles to quickly address security threats. It also provides Verint a competitive advantage.

In Q2, our software model continued to drive gross margin expansion of approximately 500 bps year over year. I'm pleased to report a 71% non-GAAP gross margin on an estimated fully allocated basis, consistent with the trend of ongoing margin expansion over the last few years. In summary, we continue to see demand for our solutions as threats are becoming more complex, and government and enterprise organizations continue to seek new analytical security software. Looking forward, we expect the gradual lifting of travel restrictions to drive sequential non-GAAP revenue growth in Q3 and in Q4.

And overall, we believe our cyber business is a category leader and well-positioned to be a successful independent software company. We continue to make good progress, creating two strong independent public companies, and I would like to share some key milestones. We expect to make our initial confidential submission to the SEC later this month. During the Q3 conference call, we will provide additional details on the separation.

In January, we plan to conduct a virtual roadshow for analysts and investors. And finally, as we discussed, we expect to complete the separation shortly after the fiscal year ends. Now let me turn the call over to Doug to discuss our financial results in more detail. Doug?

Doug Robinson -- Chief Financial Officer

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. As Dan mentioned earlier, the combination of strong sequential revenue growth, combined with COVID-related expense controls, resulted in strong year-over-year growth in non-GAAP diluted EPS and a nearly 40% increase in cash from operations in the first half. We are pleased with our Q2 performance and believe we are well-positioned for a successful second half of the year.

Today, I'll review our results for each of our two segments, provide an outlook for the rest of the year, and provide an update on our separation plan. This is our customer engagement dashboard that can be found on our IR website. It shows the key metrics for our customer engagement business, which we believe are helpful to understand the performance of our business. Let me highlight some key customer engagement metrics for Q2.

As Dan discussed earlier, we had a solid cloud quarter. New SaaS ACV was up 65% year over year. Non-GAAP cloud revenue, excluding ForeSee, was up 28% year-over-year. The strong cloud growth, partially offset by the COVID impact perpetual licenses, resulted in a 3% increase in perpetual license equivalent bookings.

Looking forward, we expect continued cloud momentum with on-premises deals to gradually come back, driving mid to high single-digit growth in perpetual license equivalent bookings in the second half. Overall, revenue increased sequentially from Q1. However, due to COVID, was down year over year. Looking forward, given our strong momentum, we expect sequential non-GAAP revenue growth in both Q3 and Q4.

We are pleased with the continued growth of our recurring revenue in Q2. We believe recurring revenue provides stability and predictability to our business and is a useful metric to measure where we are in our cloud transition. I'd now like to discuss our recurring revenue expectations going forward. In Q2, non-GAAP recurring revenue as a percentage of software revenue reached 80%, up 600 bps year over year.

Given the strong momentum of our cloud business, we expect 85% of our software revenue to be recurring within two years. We believe 85% will signify the substantial completion of our cloud transition as we expect a small number of very large customers to continue to purchase perpetual software as they've done in the past. In Q2, non-GAAP estimated fully allocated operating margin for customer engagement came in around 31%, reflecting the improving business conditions with respect to our revenue and the cost controls we began to put in place at the end of Q1. Overall, we are pleased with our cloud momentum in Q2 and expect continued cloud momentum in the second half of the year.

Now I'll provide a few comments on our cyber intelligence segment. This is our cyber intelligence dashboard that can be found on our IR website. It includes key metrics we believe are helpful to understand the performance of the business. Let me highlight some key cyber intelligence metrics for Q2.

In Q2, as Dan mentioned, we received many large multimillion-dollar deals, which will be converted to revenue over time. While on-premises deals and revenue were impacted from COVID, gross profit was particularly strong as we continue to execute on our software model transition. Non-GAAP estimated fully allocated gross margins came in at 71%, an approximate 500 bps increase year over year. Non-GAAP estimated fully allocated operating margins came in at 20%, up 600 bps year over year.

Overall, demand for our cyber solutions continues and we expect sequential non-GAAP revenue growth in Q3 and Q4. And now turning to our balance sheet. We have nearly $850 million of cash in short-term investments, net debt of $131 million, and a leverage ratio of less than one times net debt to adjusted EBITDA. Our cash flow from operations on a GAAP basis was strong in Q2, coming in at $61 million and was $137 million for the first half, up 39% year over year.

Overall, we have a strong balance sheet to support the separation of Verint into two public companies. During the quarter, we made good progress preparing for the separation. As Dan mentioned earlier, we expect to make our initial confidential submission with the SEC later this month and are on track to complete the separation shortly after fiscal year end. Before taking questions, I'd like to summarize.

We are pleased with our Q2 results and our view of the year has improved, and we now expect non-GAAP revenue to increase sequentially in both Q3 and Q4. Typical of past years, we expect a small sequential revenue increase in Q3 and to finish the year with our normal seasonally strong Q4. With the market conditions improving, in Q3, we plan to return to OPEX levels similar to last year's Q3 to support our long-term growth plans. We expect adjusted EBITDA for the full year to be flat year over year despite COVID impacting our top line this year.

Overall, we're pleased with our performance during COVID, including the strong execution of our cloud strategy, customer engagement, and our software model strategy in cyber intelligence. We're also pleased with our progress on the separation and look forward to creating two strong independent public companies shortly after fiscal year end. That concludes our prepared remarks. So operator, can we now open up the call for questions?

Questions & Answers:

Operator

Certainly. [Operator instructions] Our first question comes from the line of Shaul Eyal with Oppenheimer.

Shaul Eyal -- Oppenheimer & Co. Inc. -- Analyst

Thank you. Good afternoon, gentlemen. Congrats on the quarterly performance. Very solid.

So I want to start Dan with the cloud business really showing strong quarterly performance, strong momentum. What do you see going forward as it relates to specifically the cloud business? I know that you've provided some directional qualitative commentary, but anything additional will be highly appreciated. And I have a follow-up.

Dan Bodner -- Chief Executive Officer

Yes. Sure. Thank you, Shaul, for the question. So, yes, strong momentum in Q2.

We also see a noticeable shift in our pipeline toward the cloud. So that's clearly, as we discussed last time, the impact of COVID and cloud adoption is improving by the market. So we now expect that we will complete a cloud transition within the next six to eight quarters. As we progress through that transition, obviously, new perpetual equivalent bookings is a useful metric to understand our growth.

Despite COVID's impact on slowing down perpetual deals, we did have 3% growth in the perpetual equivalent bookings, and that's driven by the strong 65% of new SaaS ACV growth. We expect to continue to see improvements in H2 in new perpetual booking and improve to the mid to high single digits over the next two quarters as the business environment continues to improve. And I think also, it's important to highlight that we see now that almost half of our new perpetual equivalent bookings in H1 came from the cloud. And that's compared to only one quarter that came in from the cloud in H1 last year.

So this is major progress in the mix in our booking growth, that is now almost half from the cloud. And obviously, we expect that also to continue to improve as we complete the cloud transition. So the bottom line is there's a lot of momentum now. I think it started last year.

And definitely COVID had a positive impact on the market in terms of customers' interest in moving to the cloud perhaps faster than they thought before.

Shaul Eyal -- Oppenheimer & Co. Inc. -- Analyst

Got it. Got it. And switching to the cyber intelligence business. Also very, very encouraging trends taking shape within that division.

As we think about it from a geographic perspective, and as you start looking into the second half and later on into the separation, anything different this quarter as we're beginning to see some stability, emerging markets, EMEA, U.S.? Any light you can shed will be greatly appreciated.

Dan Bodner -- Chief Executive Officer

Yes. So in terms of demand, we still see very strong demand even during COVID. There are security challenges that perhaps are evolving. There are some new ones.

So customers really are in having discussions related to new needs and how analytical software can help them to address their needs. I think the biggest impact on COVID is travel restrictions. This is primarily in the government side, it's primarily on-premises business. And our inability to travel, and in some cases, the customer's inability from on-premises deployments has basically had some impact on the business this year.

I can say that we are working very well with customers through virtual communications. We're doing more remote work than we've done before. So customers are more accommodating remote work because of the urgency to deploy mission-critical software. But we believe that as the travel restrictions will ease all over the world that will create a positive impact on growth rates.

And the other thing is obviously the mix shift toward more software and less services continue. We had 71% gross margin in this business. So we're pretty much where we wanted to be. And as we continue to reduce the amount of hardware and services, which is a multiyear trend, we expect gross margin to continue to expand over the next few years to the mid-70s.

So it's been a very positive trend over the last few years, which we expect to continue. And of course, in addition to providing better margins, it does provide the customer benefits in terms of faster access to innovation and faster refresh of software, which is very important in this dynamic environment where the security challenges are evolving very quickly.

Shaul Eyal -- Oppenheimer & Co. Inc. -- Analyst

Got it. Congrats.

Operator

Thank you. And our next question comes from the line of Ryan MacDonald with Needham.

Ryan MacDonald -- Needham and Company -- Analyst

Good afternoon, gentlemen. Thanks for taking my questions, and congrats on a solid quarter. Dan, can you talk a little bit about, I guess, within customer engagement, obviously, seeing some nice momentum for the cloud. Can you talk about what the mix of that is between sort of net new business that is cloud-focused versus maybe more of a willingness of your existing on-prem customers that are looking to accelerate their shift or migrate to the cloud?

Dan Bodner -- Chief Executive Officer

Yes. What we see is interesting because while customers are starting to move to the cloud and they buy new business in the cloud, there's been a little bit of a pause in terms of converting the legacy, especially in Q1, it's been a little bit better in Q2 because it's working. And right now, they have higher priority. They're trying to obviously deal with the workforce at home.

Initially, it was all about just making them work at home, but now they're starting to see all the consequences of losing productivity, ensuring compliance, having analytics to ensure that they can create the right efficiencies, coaching, and real-time guidance to the workforce at home. So all this has come to play. And we definitely see customers that are willing to buy new stuff in the cloud, while they're not seeing that as urgent to convert their legacy on-prem software to the cloud. But we do have a lot of conversations with many customers around conversions.

And once this environment will become more stable, I think we'll see a pickup in conversions as well. Obviously, customers that are already buying something to the cloud, it's just a matter of time before they will pick up the conversion. So I would say the discussions, the concerns that customers have with cloud have been diminishing in many cases. We still have a small number of very large customers that express a preference to continue to buy perpetual.

This is relative to our thousands of customers. This is a very small number, but they've been important customers to Verint, and we will continue to support perpetual biz as well.

Ryan MacDonald -- Needham and Company -- Analyst

Excellent. And then as a follow-up, you talked about working and really investing to expand the partner network. Can you talk about where you're at right now in terms of bookings or a mix percentage of deals that are coming direct versus the partner network and ideally where you'd like to see that mix go over the next 12, 24 months?

Dan Bodner -- Chief Executive Officer

Yes. So the partner strategy is not a new one, and we're already generating about 50% of our business through partners. We've been discussing our partner neutrality and our broad partner network already over the last couple of years. But we believe that, especially as I look forward, we are uniquely positioned as a strategic partner.

Because of this agnostic strategy and also because of the open cloud platform, it makes it easier for partners to deliver customer value with the cloud-to-cloud connectivity to the Verint cloud. So we're now investing in helping existing partners to sell more of our cloud portfolio. In some cases, we have many parties that sell only a portion of the portfolio. So that's obviously engaging with partners and enabling them on more solutions.

And we're also recruiting new partners. And in that regard, I'm happy to welcome 8x8 to our partner program as we recently signed a new agreement with 8x8. So I'm not going to give specific guidance on the mix. But obviously, with our investment in partners, and we believe also partners makes even a more important role for our customers in terms of delivering services and helping them to use technology more effectively.

So altogether, we expect the mix to be more than 50% partners, through partners over the years.

Ryan MacDonald -- Needham and Company -- Analyst

Got it. And just one last follow-up, I guess, to that question. Are you seeing now as we -- in this shift to the cloud that the decision or the purchase decision on, say, workforce engagement management is being linked in more often with a cloud UC or cloud contact center transition?

Dan Bodner -- Chief Executive Officer

Yes. We definitely see that in the SMB market, and that's why we sell exclusively through partners. But what's interesting about the SMB market, even our SMB partners, when they try to win a bigger deal, they tend to work with the Verint sales force to help them to differentiate, and obviously, you differentiate with functionality. So at the small end of the market, the vendors tend to package everything as a suite, and customers tend to prefer to buy that as a suite.

But as we start to move upstream, customers are looking more functionality, and they're trying to make sure that they get the best value because, obviously, functionality affects their business. It's not just the infrastructure cost, but it's also the opportunity to improve the efficiencies, cut costs, and at the same time, elevate the customer experience. So we certainly play exclusively at the SMB market with partners and work through partners. But at the mid to high end of the market, we see customers that are choosing for communication infrastructure, certain components from the vendor, and for business applications, they choose what is the best value that they can get and the highest ROI, they believe they can generate.

Ryan MacDonald -- Needham and Company -- Analyst

Excellent. Thanks again.

Operator

Thank you. And our next question comes from the line of Paul Coster with JP Morgan.

Paul Coster -- J.P. Morgan -- Analyst

Thanks for taking my questions. Quick ones. Well, first off, is there any commonality in the demand you're seeing across the cyber intelligence sector? Any themes that you can point out to us?

Dan Bodner -- Chief Executive Officer

I think the commonality is in the area of analytics. I mean, both businesses as a legacy of working in a very data-intense environment and our claim to fame is the ability to apply data sciences and whether it's machine learning or predictive analytics or cognitive analytics. And there is a demand for this type of insight regardless of the market, obviously, for different purposes, but there's exponential growth in data. People working from home actually increased the amount of data.

There's more digital connection and people have more time. So data is growing. And obviously, the ability to get insight and use this insight in real-time or near real-time, are big competitive advantages that our customers are looking to have. But as we explained, Paul, and you know that very well, while the core technology has been very similar, the use cases, the market, the go-to-market has been different, and that's why we are committed to the separation.

We are actually less than five months away from the separation. So it feels like it's just around the corner.

Paul Coster -- J.P. Morgan -- Analyst

Yes. And I think it's kind of aid in transparency and understanding very well. The other question I've got is social security engagement. Can you give us some sense of the magnitude, the duration, what kind of engagement? Is it primarily cloud? Just anything that helps us sort of understands that projects roll in your future revenues and earnings?

Dan Bodner -- Chief Executive Officer

Sure. So very pleased to be selected. It's a large-scale project. Let me give a few details for those that didn't follow-up on the history, and then I'll go to the size of the opportunity.

So it's a project that was awarded in July 2019, and there was an appeal process that took over a year. At this point, the project has been awarded by the FSA and delivery milestones are currently under discussion. So we're still under discussion on milestones. Therefore, today, we're not yet in a position to share a firm delivery schedule.

But I can confirm that in Q2, we already received the initial order. It was a perpetual license order. And we've delivered less than $5 million revenue that is in the Q2 number. Now in terms of overall for the full scale of the project across all the phases and including software and services, this is an opportunity for Verint that is well over $50 million.

Paul Coster -- J.P. Morgan -- Analyst

Gotcha. And that brings me to my last question is, those customers that are sticking with perpetual licenses, why are they doing so?

Dan Bodner -- Chief Executive Officer

So many customers are building their own cloud. And since our software is cloud-ready and we support multiple clouds, and that was investments we made over several years now. Obviously, we support several public clouds and we have a number of public clouds we deploy, but we also build the software to support customer clouds. So that gives very large customers to invest in their own cloud, the ability to basically look at if they want to use the software for five, seven years, are they getting better economics owning the software than leasing the software.

Typically, when we did the analysis of what in our base, these are large companies that have been buying expansions from Verints almost every year. And it's a multimillion-dollar expansion on average annually. So they haven't always a recurring type of behavior. But for now, they still prefer the perpetual model.

And we'll see what happens over time, but the vast majority of our customers, we believe, will move to a recurring model, and that's why we target 85% of our software being recurring, this is our goal for the end of the cloud transition. And the remaining customers will be a small number of customers that will continue for a number of years will be in perpetual. And we believe we can get to 85% in about six to eight quarters.

Operator

Thank you. [Operator instructions] Our next question comes from the line of Daniel Ives with Wedbush.

Daniel Ives -- Wedbush Securities -- Analyst

Yeah. Thanks, and a great bounce-back quarter. So walkthrough, let's say, when you're looking at the rest of the year, I mean, what are your thoughts in terms of just how it plays out? Obviously, a nice uptick this quarter. It seems like close rates increasing pipeline.

Can you just maybe give some commentary on the next few quarters?

Dan Bodner -- Chief Executive Officer

Yes. So maybe turn it over to Doug to perhaps share some of the internal models that we have. Doug?

Daniel Ives -- Wedbush Securities -- Analyst

It's always Doug that gets the hard questions.

Dan Bodner -- Chief Executive Officer

Yeah.

Doug Robinson -- Chief Financial Officer

Yeah. Hey, Dan. Yeah. As we've just talked about, Q2 was strong for us, and we see sequential improvement in Q3 and Q4 is normally a pretty good quarter off of Q3.

And we see that also this year. But given COVID the first half being down off last year's levels, even with a good second half and despite strong cloud bookings, we'll probably still be down around 5% year over year in terms of total revenue. Our gross margins, we expect to continue to increase a bit. In the first half, they were around 69%.

Q3 probably similar, but then Q4, probably up a point or so, based on the higher revenue. Some of that cost of sales is fixed, and that will pop the margin up a bit. We do expect to kind of get back to some operating expense growth in the second half. We clamped things down in the first half and particularly in Q2, as you saw.

But that's really not sustainable if we want to get back to a growth trajectory. So Q3 operating expenses will probably get up to last year's level, and then sequentially, probably another $10 million or so into Q4. And all that, your models are probably there already because we had talked about a flat EBITDA year over year despite the revenue being down, and that's where we're still headed. So we expect to achieve that.

And then kind of below the line, just to help you guys out with some of the modeling. Interest expense is probably kind of net with interest income, and probably that's $6.5 million a quarter. We have some FX translations that pop that down a little bit in Q2, but $6.5 million is probably a steady-state rate, absent kind of translation gains or losses, which are impossible to predict. Right? Tax rate probably continues to be around 7.5%.

And with the Apax investment you saw in Q2, the share count jump. So the way that's accounted for is extra shares instead of the dividend as an expense. So our shares will be probably just under $70 million in the second half, similar to what we had in Q2. And then continuing on, we expect some growth into next year and continue to make investments and driving performance and income.

Does that help?

Daniel Ives -- Wedbush Securities -- Analyst

Great. Yes. No. It really does.

And for you, Dan, obviously, a lot of questions about Palantir. Can you just maybe talk about just the view of that, like how you guys compare and contrast in sales cycles?

Dan Bodner -- Chief Executive Officer

Sure. I'll try to give you the short answer. There's a lot to talk about Palantir because they now open to Kimono, and we see more about their performance. Anyway, we believe that we operate in the same market.

We provide customers, analytics, and actionable intelligence. And there are some similarities and some differences between the two companies, so I'll just go over a couple of dimensions. So first, as the market for analytical software, both companies deliver highly scalable software with an open data approach and really strong Big Data analytics. Palantir targets $119 billion TAM according to their filings.

Where we are targeting at this point, a subset of this market was about $25 billion TAM. We plan to expand our target TAM over time as we scale. But just for example, their TAM includes government agencies across many different types of agencies as well. Our TAM is focused on the national security agencies in our cyber business.

In terms of the margin profile, that's another dimension. The gross margin is very similar in the 70s. And we both are providing an open software platform to help customers use and manage and enhance the software by themselves. But despite a similar gross margin on the operating margin is very different.

Our strategic priority is to remain profitable with positive cash flow, and we've been successful in that all along, while Palantir incurred big losses and cash burn. So in line with the strategic focus on profitable growth, we chose to focus on an initial TAM and this allows us to control our operating expenses. And over time, as we scale, we plan to expand our TAM, while at the same time, improve gross margins and operating margins. So I would say that in terms of competition, we generally see Palantir in a limited number of customers.

They are more concentrated. They have about 150 customers, while we have a thousand customers. Well, I think what's interesting that overall, we believe that Palantir approach of selling open analytical platforms is really good for the market and validates the Verint approach. You know that we've been educating the market for many years about the power of actionable intelligence and the benefits of the software model.

But the reality that 10 years ago, we used to compete with large system integrators and we had to offer system integration services because this is the way the market wanted to consume these types of solutions. But now, we're glad to see the market is shifting and more to the open software model. And overall, this is a very big potential ahead and in a very large TAM.

Operator

Thank you. I will now turn the call back over to Alan Roden for closing remarks.

Alan Roden -- Senior Vice President, Corporate Development

Thanks, operator, and thanks, everyone, for joining us tonight. Have a great evening. We'll see you again on our next call.

Operator

[Operator signoff]

Duration: 49 minutes

Call participants:

Alan Roden -- Senior Vice President, Corporate Development

Dan Bodner -- Chief Executive Officer

Doug Robinson -- Chief Financial Officer

Shaul Eyal -- Oppenheimer & Co. Inc. -- Analyst

Ryan MacDonald -- Needham and Company -- Analyst

Paul Coster -- J.P. Morgan -- Analyst

Daniel Ives -- Wedbush Securities -- Analyst

More VRNT analysis

All earnings call transcripts