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Executives

Michael Picariello – Director, IR

Bob Hammer – Chairman, President and CEO

Lou Miceli – CFO

Al Bunte – COO

Analysts

Tom Curlin – RBC Capital Markets

Aaron Rakers – Wachovia

Samad Samana – Morgan Keegan

Aaron Schwartz – JPMorgan

Rajesh Ghai – Think Equity

Brent Bracelin – Pacific Crest Securities

Steve Koenig – KeyBanc Capital Markets

David Bayer – Cantor Fitzgerald

Derek Bingham – Goldman Sachs

Dennis [ph] – Credit Suisse

Tim Klasell – Thomas Weisel Partners

Joel Inman – Robert W. Baird

CommVault Systems, Inc. (CVLT) F2Q09 (Qtr End 09/30/08) Earnings Call Transcript October 29, 2008 5:00 PM ET

Operator

Good afternoon, ladies and gentlemen, and welcome to CommVault’s fiscal second quarter 2009. At this time, all participants are in a listen-only mode. Following today’s presentation, instructions will be given for the question and answer session. At this time for opening remarks and introductions, I would like to turn the call over to Mr. Michael Picariello, Director of Investor Relations. Please go ahead, sir.

Michael Picariello

Good afternoon. Thanks for dialing in today. With me on the call are Bob Hammer, Chairman, President, and Chief Executive Officer; Alan Bunte, Chief Operating Officer; and Lou Miceli, Chief Financial Officer.

Before we begin, I would like to remind everyone that statements made during this call including in the question-and-answer session at the end of the call, that relate to future results and projections are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are based on our current expectations.

Actual results may differ materially due to a number of risks and uncertainties, which are discussed in our SEC filings and in the cautionary statement contained in our press release and on our website. The Company undertakes no responsibility to update the information in this conference call under any circumstances.

Our earning press release was issued today over the wire services after the market closed and has also been furnished to the SEC as an 8-K filing. The press release is also available on our Investor Relations website.

On this conference call, we will provide non-GAAP financial results. The reconciliation between the non-GAAP and GAAP measures can be found in Table IV accompanying the press release and posted on our website.

This conference call is also being recorded for replay and is being webcasted. An archive of today’s webcast will be available on our website following the call.

I will now turn the call over to our CEO and President, Bob Hammer.

Bob Hammer

Thanks, Michael. Welcome, everyone, and thanks for joining our Fiscal Second Quarter 2009 Earnings Call. For the quarter, we achieved revenues of $63.3 million, up 34% on a year over year basis versus $47.4 million in fiscal Q2 2008. Software licensed revenue grew on a year over year basis by 32% while our services businesses grew 35% year over year. For the quarter, non-GAAP operating income or EBIT was $10.4 million, up 49% year over year versus EBIT of $7 million in fiscal Q2 2008. Non-GAAP earnings per share for the quarter were $0.17.

Free cash flow for the quarter was $13 million, up approximately 240% from the prior year quarter. Lou Miceli will go into more detail about our financial results and updated guidance later in the call. As I normally do, let me provide some color on how Simpana 7.0 is doing along with deal stats before speaking about the broader macroeconomic environment.

For fiscal Q2, sales of our advanced data and information management products or ADIM products which do not include backup products grew 76% year over year. ADIM products represented 30% of software revenue versus 23% in Q2 of last year. Archiving, single instancing replication, and search functionality continued to be the key drivers for the growth of these products.

Currently, approximately 50% of our entire installed base is using Simpana 7.0. We added 274 new customers in the quarter. As usual, the new customer additions did not include a large number of small orders from new OEM customers who registered throughout the internet. Our customer base now totals approximately 9,100.

In the second quarter of fiscal 2009, approximately 52% of our software revenue came from deals over $100,000 comparing with 37% in the second quarter of last year and up from 29% in the first quarter of fiscal 2009. The dollar volume of deals over $100,000 grew 84% year over year. This statistic supports our decision to focus our efforts and strategies on the large enterprise accounts and also indicates the increasing competitive advantages of our single, unified data and information management platform, the increasing leverage from our strategic partners, distributors, and borrowers, and the success of our increased market awareness campaigns.

In deals over $100,000, sales of our ADIM products represented approximately 41% of the sale in the second quarter compared to 33% of the sale in the second quarter of fiscal 2008. We believe this stat demonstrates the increasing acceptance of our Simpana platform at the enterprise level.

Going forward, we’ll continue to focus on increasing our penetration of large enterprise accounts. In addition, we have developed and implemented a series of initiatives aimed at strengthening our position in the SMB segment of the market. We are confident that these initiatives can have a substantial impact in increasing our SMB market share.

Turning now to international operations, international operations generated 39% of our total revenues in the quarter with the United States operations generating 61%. International revenue was up 61% in Q2 FY ‘09 versus the same quarter a year ago. US revenue was up 21% in Q2 2009 versus Q2 2008. We continue to expand our international distribution with strong growth in Europe, Canada, Australia, and Asia.

Our outlook for international license revenue growth in local currencies remains strong, but we have built into our forecast that international revenue growth in US dollars will be negatively impacted due to the strengthening of the US dollar and subsequent weakening of local currencies. We will spend some time speaking about the FX impact of our international operations later in the call.

Moving on to our strategic partnerships, let’s talk about Dell. Sales of both our OEM and SMP relationships with Dell accounted for approximately 24% of total revenues for fiscal Q2 2009. Total quarterly Dell revenues were up 15% year over year.

As you may have seen a few weeks back, we announced that we were teaming with Dell to offer a new integrated backup to disc appliance for small and medium-sized companies. This offering is built on the new Dell PowerVault DL2000 and is the industry’s first customer installable integrated software and hardware solution powered by Simpana 7.0 software which includes built-in de-duplication. It provides comprehensive disk-to-disk based solution to help customers implement and leverage a data management strategy that is simpler and more cost effective to deploy.

We believe this speaks well about the current state of our relationship with Dell and are excited to partner with Dell on this project. We anticipate minimal revenue from this appliance in FY ‘09 but expect it to ramp up in FY 2010.

I want to talk about HDS. We continue to see very significant year over year increases in Hitachi license revenue on a global basis. We continue to feel this relationship will strengthen our global reach and will continue to contribute to our overall success.

You’ve read about our recent announcement with MacAfee. MacAfee and CommVault last week announced a strategic partnership to deliver an integrated data and security management solution built on our respective data management backup and security expertise. This will be a joint product integration effort which better aligns our marketing teams along with our field sales teams which will ultimately help broaden our distribution model.

The solutions provided by the partnership will not only help reduce the complexity in customers’ IT environments but also improve protection and compliance as well as lowering the total cost of ownership. We’re not giving specific revenue guidance at this point and have not included any potential revenue in our FY 2009 guidance. However, we do believe that this partnership will drive additional revenue opportunities in FY ‘10.

Let me spend some time speaking about the macro environment along with CommVault’s long-term vision. Despite the well publicized concerns caused by conditions in the credit and stock markets, our business continues to progress very well. Our quarter started strong and ended strong. We continue to compete successfully and pick up market share from the larger competitors in the market. Our overall funnel and big deal pipeline growth indicate healthy demand for our products across all geographies. We have seen some negative impact from the current deteriorating economic conditions, but to date, our funnel growth continues to outpace the impact of lower close rates.

CommVault will keep building strong momentum as it moves down the track. Since the release of Simpana 7.0, our success is driven by our highly differentiated Simpana data and information management platform, an average of 65% plus growth in the enterprise segment of the market, consistent 95% plus growth in our non-backup products, an average of 50% plus growth in our international operations, our move to offer new data protection technology, and increased growth of enterprise deals in the US.

In summary, CommVault’s data and information management software business thus far has shown resilience in the face of economic slowdown; however, we do anticipate that IT spend will continue to come under negative pressure over the next year. In order to mitigate this negative pressure and in addition to our core strategies, we have taken and are taking a series of anticipatory actions.

These actions include scrubbing and reverifying our funnel, raising the bar for qualifying deals into the funnel. Tighter management of the sales process, focusing on more viable vertical sectors, strengthening our channel programs, continuing to focus and reemphasize our sales efforts based on business case ROI and lower TTO versus competitive products and versus customers’ do-nothing strategies.

So far, our strategies and actions have worked. We have good visibility going into our Q3 and we see new demand building in the quarter which reinforces our core value proposition that companies will spend money in order to reduce costs and improve operational efficiencies. In addition, the following could mitigate some of the negative impacts of the macroeconomic environment and the stronger US dollar.

A potentially higher US license revenue growth rate due to a larger US big deal funnel, combined with the strengthening of our US channel program. Selective price increases in some international markets and a positive P&L impact on international operating expenses due to the stronger dollar. Given all of the above, we feel it is prudent to slightly lower the midpoint of our revenue guidance due to the negative changes in FX and modestly decrease our EBIT guidance, assuming lower revenues and relatively higher spending tied to key programs that strengthen the Company’s market position in FY 2010.

Let me talk about these investments. We continue to think that the best way to maximize long-term growth profitability and shareholder value is to continue to increase our near-term investments in R&D, sales, and distribution. We have made this decision given our consistent ability to increase market share, our solid execution of strong financial performance, the broadening and strengthening of our global distribution, increasing opportunities to add significant new strategic partners, the upcoming release of our next generation of products, the confidence in a long-term vision and strategy and the many opportunities we have to invest for business expansion.

We will continue to make these investments at the expense of some near-term operating margin growth. We have trimmed some planned growth and expenses in light of the macroeconomic situation; however, we are prepared to sacrifice short-term margin expansion for long-term shareholder value. We strongly believe that the investments we are making today in our sales force, our distribution channels, brand awareness, R&D and strategic partnerships, such as our recent announcement with MacAfee and Dell, will enable us to strengthen CommVault during this recessionary period and exit the economic environment in a much stronger relative position.

In summary, we are realistic about the recessionary state of the global economy and will modify and adjust our spending plans as necessary, but will continue to manage the business for the long-term.

Let’s talk about innovation and future product direction. Let me spend a few minutes updating you on the progress of our next generation technologies incorporated in our next software release which we expect to be the largest release in CommVault’s history. As a reminder, the development, release, and timing of any future features or functionality remain at our sole discretion. We typically have a major release every 18 months. Simpana 7.0 was released in July of 2007. Our next major release is on track. We are looking forward to some potential new product announcements later in our fiscal year.

The new release is currently in beta testing and it is performing exceptionally well. We expect the next release to be completely game changing and will, without a doubt, increase our differentiated value proposition in the market. As I have mentioned previously, we anticipate that our next release will include the following; breakthrough new ways to manage data protection, significant innovations for block level de-duplication, next generation automated records management, better ways to manage workstations and laptops, better ways to manage growth of databases, enhanced data management in virtualized server environments, next generation technology for the management of tape, and next generation technology to manage and mine applications, such as Exchange and SharePoint.

To summarize my comments, the fundamentals of our business remain strong. Our sales funnel continues to grow even with the current economic headwinds. Since the release of Simpana 7.0, enterprise deals have grown at an average year over year rate of 68% quarterly and sales of our non-backup products have been growing an average year over year rate of 96% quarterly. We continue to broaden and strengthen our global distribution, enabling our international revenues to grow approximately 50% in the first half of fiscal 2009 over the first half of fiscal 2008. We are clearly one of the fastest growing companies in our segment of the market and have consistently grown market share. I am confident that we will continue to pick up market share for the foreseeable future.

I will now turn the call over to Lou, who will provide more details about our quarterly results, as well as our FY 2009 guidance. Lou

Lou Miceli

Thanks, Bob, and good afternoon, everyone. I will cover the financial highlights for the second quarter, along with updating our fiscal year 2009 guidance.

I will start with revenues. Total revenues for Q2 were $63.3 million, an increase of 34% year over year and 15% sequentially. Software revenues were $35.2 million, an increase of 32% year over year and 27% sequentially and services revenue was $28.2 million, an increase of 35% year over year and 3% sequentially.

Software revenue generated through indirect distribution channels was approximately 84% of software revenue for the quarter compared to 83% in the prior year period. The revenue for the quarter was 56% software and 44% services. We continue to anticipate the split for the year to be 55% software to 45% services. Despite the current macro environment, our maintenance attach rates continue to remain very high and our renewal rates remain strong on a worldwide basis. I will address the impact of foreign exchange rates on our deferred revenue balances later in my comments.

Gross margins were 87.9% for the quarter. Gross margins on our software revenue were 98.2% in the current quarter versus 98% for the prior year quarter. The gross margin for services revenue was 75% in the current quarter versus 73.2% in the comparable prior year period.

Moving on to operating expenses. Total operating expenses were $44.3 million for the quarter. Sales and marketing expenses increased by $9.1 million or 41% over the prior year period. Approximately two-thirds of this increase was related to employee compensation which includes the additions of new employees, as well as increased commissions on higher revenue. The rest of the increase was primarily due to higher travel and related expenses and higher advertising and marketing expenses.

Research and development spending increased by about $1 million in the quarter or 16% over the prior year period. We continue to leverage our investments in R&D by expanding our Hyderabad, India location.

G&A expenses increased by $600,000 or 12% over the prior year period. This increase primarily relates to higher headcount, higher public company costs, as well as higher legal expenses. We added 68 employees during the quarter, bringing total worldwide headcount to 1001 at the end of September. The headcount increases were primarily in sales, technical services, and research and development in India.

Non-GAAP operating margins were 16.5% for the quarter, resulting in non-GAAP operating income of $10.4 million. This represents EBIT growth of approximately 49% year over year.

The non-GAAP net income for the quarter was approximately $7.7 million and non-GAAP EPS was $0.17 per share based on a diluted weighted average share count of approximately 44.5 million shares.

Now moving on to the balance sheet. Cash flow from operations was approximately $14.2 million in Q2, up approximately 217% over the prior year quarter, primarily due to the increase in operating income, higher deferred revenue, and strong collection efforts on accounts receivable balances.

Free cash flow, which we define as cash flow from operations less capital expenditures came in at $13 million for the quarter, up approximately 240% over the comparable prior year quarter. As of September 30th, our cash balance was $101.3 million, up from $98.2 million at the end of June. This cash balance is net of about $9.6 million used for our stock repurchases during the second quarter.

During the quarter we repurchased approximately 650,000 shares of our common stock for a total of approximately $9 million of which $6 million was paid for as of September 30th, 2008. Under the current program to date, we have now purchased approximately 40.2 million of CommVault stock since February 2008 when the repurchase program was announced. This represents a total share repurchase of approximately 2.9 million shares or roughly 6.5% of our outstanding shares. We are authorized to repurchase an additional 39.8 million under the existing repurchase program.

Our DSO was 56 days. This is down from 69 days in the prior quarter. It is primarily due to higher revenues during the quarter on lower accounts receivable balances. Deferred revenue increased approximately $1.8 million or 3% sequentially over the prior quarter. This is lower than historical sequential increases, primarily because of foreign exchange. On a constant currency basis, deferred revenue would have increased by approximately $4.1 million or 6%. Capital spending was approximately $1.2 million in Q2. Our current estimate for fiscal year 2009 capital spending is between $5 million and $5.5 million.

Now a few comments on taxes. We are using a non-GAAP pro forma tax rate of 30% during fiscal year 2009 compared to a 28% non-GAAP tax rate used in fiscal year 2008. We believe that the use of non-GAAP pro forma tax rate is a useful measure to compare operating results on a consistent basis over multiple periods without the impact of significant variations. Our GAAP tax rate for the past few years has varied greatly by quarter while our cash tax rate has remained relatively low. The cash tax rate in Q2 was approximately 10% while the GAAP tax rate was approximately 43% which was up from 32% in Q1 of fiscal 2009.

We continue to implement worldwide tax planning strategies that we anticipate will bring the long-term terminal GAAP tax rate within the range of 30% to 32%. We are estimating that the cash tax rate for the full fiscal year 2009 will be approximately 10% to 15%. This is primarily because we have recorded on our balance sheet approximately $51.3 million of deferred tax assets that will be used to mitigate cash taxes over the next 12 to 18 months. Over time, our cash tax rate will approach our long-term terminal GAAP tax rate.

Now I want to spend a few minutes speaking about our foreign exchange exposure. Most of our international business is transacted in foreign currencies. Our international revenue was 39% in Q2 and 40% for the six month period ended September 30th, 2008. Our expenses and our revenues overseas are naturally and reasonably hedged because we price and invoice in local currency and customers generally pay us in local currency.

So, if foreign currencies are strengthening as compared to the US dollar, causing revenues to increase, then expenses are going to increase on a relative basis as well. On the other hand, if foreign currencies are weakening, causing our revenues to decrease, then our expenses generally decrease again on a relative basis.

On a constant currency basis, foreign exchange positively impacted our second quarter revenues by about 5% while negatively impacting expenses by about the same percent year over year. Therefore, EPS was minimally impacted by about $0.01 per share in the September quarter.

Recently, we have seen extraordinary movements in global currency rates resulting in a strengthening of the US dollar. We have lowered our revenue guidance to reflect the more recent moves in foreign exchange rates. In addition, our revenue guidance reflects some selective international price increases to offset the negative impact of foreign exchange.

Also, there is potential for higher relative revenue growth rates in the US for the next six months which could mitigate some of the risks if the dollar continues to strengthen beyond the current levels or stays at the current levels. Our revised EBIT assumptions reflect both the impact of foreign exchange and selective incremental spendings to support our distribution and our new product initiatives.

Now I’ll move on to guidance for Q3. As Bob noted on our last earnings call, due to the uncertainties in the equity markets and more recently in the foreign exchange markets, as well as the macroeconomic environment, we feel that it is prudent to continue to provide quarterly guidance as we did last quarter.

For the three months ending December 31st, 2008, we expect our revenues to be in the range of $63 million to $65 million, the midpoint of which represents revenue growth of 27% year over year and 1% sequential growth. Based on this revenue level, we are expecting Q3 2009 non-GAAP gross margins to be approximately 87%.

We are also expecting non-GAAP EBIT margins to be in the range of 16% to 17% for the quarter. Using a share count of approximately 43.5 million shares and excluding any potential future stock repurchases and applying a pro forma tax rate of 30% for the quarter, we are expecting non-GAAP earnings per share to be between $0.17 and $0.19 per share for the third quarter.

The quarterly non-GAAP guidance excludes approximately $0.04 per share related to the effects of stock based compensation expense under FAS123R which is net of non-GAAP income tax expense of approximately $0.02 per share.

Now for the full year, we anticipate fiscal year 2009 revenues to be in the range of $247 million to $250 million, the midpoint of which represents revenue growth of 25% year over year. Based on this revenue level, we are expecting fiscal year 2009 non-GAAP gross margins to be approximately 87%. We are guiding to a non-GAAP EBIT range of 15.5% to 16.5% for the year. Using the midpoint of our guidance, this represents EBIT growth of approximately 22% year over year.

Using a share count range of approximately 44 million to 44.6 million shares and also excluding any potential stock repurchases and applying a pro forma tax rate of 30% for the full year, we are expecting non-GAAP earnings per share to be in the range of $0.66 to $0.68 per share. The non-GAAP guidance excludes approximately $0.16 to $0.17 per share related to the effects of stock based compensation expense under FAS123R which is net of non-GAAP income tax expense of approximately $0.07 per share.

That concludes my prepared remarks and now I’ll turn the call back over to Michael who will open it up to Q-&-A.

Michael Picariello

Thanks, Lou. Before we open up the lines for your questions I’d like to highlight an upcoming Investor Relations Event. Bob will be speaking at the 2008 Goldman Sachs Software and IT Services Retreat in NY next week, November 4th at 1.15 P.M. Eastern Time. Bob’s presentation will be available live on our IR website and will also be archived for approximately 90 days.

Let’s open the lines for questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Tom Curlin with RBC.

Tom Curlin – RBC Capital Markets

Hi. Good afternoon. Can you hear me?

Michael Picariello

Yes, Tom.

Tom Curlin – RBC Capital Markets

Congratulations. Good quarter. Good guide. I think philosophically, though, what I’d like to understand is the approach or principles you’re going to follow in terms of OpEx in the event the revenue does not go up as you might expect just given downside scenarios in this kind of environment. You mentioned, if you will, not focusing on margin expansion, but you’re guiding to say 16 or so for the year; is that a hard number? Is that a hard line? If macro gets worse and it looks like the revenue’s just not there, what level of commitment do you have to that sort of 16% level?

Bob Hammer

I understand, Tom. Number one, in spite of this current economic environment, we’re seeing quite a bit of expansion opportunity that we hadn’t anticipated on the upside and I think I spelled it out.

One, this next release is turning out to be, as we get through the betas, we’re always very enthusiastic about it, but we’re even more enthusiastic about that now. Besides, in addition to the distribution opportunities we’ve talked about, we see some other opportunities opening up that could drive revenue. In addition to that, beyond the next release, we’ve got the release after that pretty well sculpted out and we’ve got a long-term strategic direction. That will not only continue to enhance our value proposition versus competition, but will continue to open up some major new markets for us.

So, the Company continues to see lots and lots of opportunity to expand the business and we think for long-term shareholder value, it really would be a shame to not to invest realizing those opportunities and I can tell you, I’ve been doing this for a long time, and I know we’re in extraordinary times here, but every company I’ve managed through these recessions, we’ve come out much stronger in 100% of the cases. So, unless there’s something very catastrophic out there, we will continue to prudently invest for long-term value and there is, at the moment, there’s more potential for upside than downside, but if we see some downside occurring, we will take appropriate action, but we are not committing that we’re going to take a hard line on that 16.5% operating margin, but we will do the right thing for shareholders over the long-term.

Tom Curlin – RBC Capital Markets

On the investments that you’re talking about, I mean, how are they distributed or what’s the mix of incremental investment in, say, R&D versus go to market overseas and so forth, the kinds of things that can be pulled back to some degree if you need to make a hard right turn or something like that?

Bob Hammer

If you look at the numbers, it’s primarily in the sales and marketing area on a relative basis is where the bulk of the investments are going and those investments are going for additional sales and channels reps. We are spending money to increase the marketing expenses for the launch of our next generation Simpana. We are doing things to significantly enhance our sales and channel partner programs and training. We’ve got those in place now and we’re in a position to strengthen those. We just announced a partnership with MacAfee.

That is a major opportunity. It doesn’t come free. We have invested money to deal with that. The Dell PowerVault and EqualLogic, there are investment overrides to drive those products into the market. We have some pretty significant new distribution initiatives that I can’t talk about it yet, but they are material to the Company. We continue to selectively expand geographically where we know we’ve got revenue. We’ve been in these markets and there’s revenue opportunities opening up for us and we keep validating that.

So, that’s where the bulk of the investments are. As I mentioned, we continue to invest in R&D and our next generation product, next release which is coming out next quarter and Alan and the team have been working on defining the release after that. We’ve made lots of progress there and feel really enthusiastic about that and from an infrastructure standpoint, as we grow and build the Company, we are a Company that works by processes and controls and we want to make sure that we continue to grow the Company with good processes and controls in place, so that frames it for you.

If things radically change, we’ll make the appropriate adjustments to our spend rate, but those are the main areas that we’re focused on right now.

Operator

Your next question comes from the line of Aaron Rakers with Wachovia. Please proceed.

Aaron Rakers – Wachovia

Yes. Thanks and also congratulations, a couple of questions from me. More housekeeping, first of all, I guess, first, did you disclose what the Arrow contribution was for you this last quarter, and then, also, can you give the breakdown between Dell OEM versus reseller, and I do have a few additional questions.

Bob Hammer

Yes. The Arrow contribution in Q2 was 20% versus 19% in Q1 and Dell in total – I’m sorry. I had to get the right Q2 here. It was 24% and it was split between, 20% was reseller and 4% was OEM.

Aaron Rakers – Wachovia

Perfect and then can you talk a little bit, it sounds like you guys are seeing some relative strength within the US and it sounds like some opportunities may be now starting to happen with regard to Arrow and maybe broadening your distribution channel. Can you talk a little bit about the funnel, what you’ve seen so far in October, and any metrics maybe that might be helpful around that?

Bob Hammer

I’ll talk about it, Aaron, in a relative basis. We have seen a consistent increase in the funnel at the early stage of the quarter. In fact, it is either right on target or a little bit better than our internal forecasted funnel growth for the quarter. So, and we’ve seen it in areas where we are focusing. As this economy has shifted, globally, our sales force has shifted to those verticals and those accounts that have budgets and money to spend. That includes the federal government. There are stronger financial institutions that are spending money today. Healthcare and pharma are spending money. Agriculture and food and energy and mining. So if you look at it globally, that is where the funnel growth is coming from.

Now, our channel strengthening, our SMB channel program is in progress, but the foundation is well built and now we’re in execution mode there. That includes ATI, Arrow-ATI in the US. In addition, we’re seeing some, I’d call it, relatively significant large deal opportunities in the US which could, I emphasize, could be quite material to near-term growth.

Aaron Rakers – Wachovia

Have you closed some of those deals already which is giving you the confidence here where obviously there’s a lot of concerns in the market but we’re pretty much well through October. Some of those larger deals have already closed, I guess.

Bob Hammer

We have seen some large deals close. On a normal basis, we’ve seen some good progress in deal closure in October. Some of these other deals I’m talking about, Aaron, are very large and they have not closed yet but they’re moving well through the sales process.

Operator

Again, we ask that participants limit their questions to one question then re-enter the queue to ask a follow-up. Your next question comes from the line of Brian Freed with Morgan Keegan. Please proceed.

Samad Samana – Morgan Keegan

Nice quarter guys. Samad Samana here for Brian Freed. I was wondering if you could speak a little bit about the linearity during the quarter. I know from Q1 to Q2 you had some deals slip into July. How did you guys do for the rest of the quarter and can you talk about the last two weeks of September and what you’re seeing so far in October?

Bob Hammer

We started very strong and we ended very strong, and the middle was not as strong. So, we ended strong and that momentum that we saw at the end of September has continued into October.

Samad Samana – Morgan Keegan

Thanks, guys.

Operator

Your next question comes from the line of Aaron Schwartz with JPMorgan. Please proceed.

Aaron Schwartz – JPMorgan

Good afternoon. I think if we look at your business over the last year or so, we’ve learned that it has been lumpy and I think it’s probably due to an increased exposure to large deal flow. Now I’m just wondering if you could provide a little more color in terms of the contribution of these larger deals in your pipeline and then also the extent of reliance on closing these large deals to make your numbers. Is there any sort of qualitative commentary you can put about coverage ratios on those large deals from your pipeline to your guidance.

Bob Hammer

Well, in Q2, on a relative basis, obviously Aaron, we closed a large proportion of those deals and particularly it was gratifying. So, a number – we had a very strong, as you know, because we had some deals that moved from Q1 to Q2. So, those closed relatively early. Almost every one of the deals that we had identified in Q1 closed relatively early in the Q2 quarter. What was more gratifying is we had a large, big deal funnel and the vast majority of those closed late in the quarter and the close rate was very high.

So, it was a good solid quarter all around and good execution from our sales teams. This quarter is what I would call a little bit more normal in terms of the flow of the quarter and I’ll give you some color. The deals happen to be – some of these deals are quite large, as I mentioned and could impact it. Most of those deals are not baked into the guidance. Some are and some aren’t. There is opportunity beyond the guidance and we’ll see how we do in closing them, but they are in close phase.

They’re not early on in the cycle. They’re at the end of the close cycle and they could help us quite a bit, not only in this quarter but going into next quarter as well. The other thing that is coming into play here is that the Company has been very focused on the enterprise but over the past year, we’ve laid a lot of foundation to swing back and put some effort into the SMB segment of the market and we’re confident that’s going to have some impact.

In addition to that, as we all know that in FY ‘08 we got a little bit behind in the US on hiring sales people and those people are just starting to come into their productivity. The full productivity curves in the December quarter, so we’re going to see some impact from that as well from this quarter going into next quarter.

So, all those things are helping us drive good, strong revenue growth in spite of the macro environment. I’ll comment on that again. We’re not immune to what’s going on globally which is the macro environment is not very good clearly and this is to date, and this could change. We are seeing companies willing to spend money to reduce costs and improve operational efficiencies. We see in another three or four quarters that look like this, we’ll clearly validate that in a recession and these types of technologies do quite well, but we’ve got one data point right now and that’s September. Let’s see how we do in December.

Aaron Schwartz – JPMorgan

So, if we sort of reconcile your comments with your guidance, it sounds like the adjustment to the top line guidance was primarily due to the fluctuation in currency. You’re seeing a larger pipeline and probably assuming a modest close rate on that larger pipeline. Is that fair?

Bob Hammer

It was 100% due to FX. The adjustments we made were 100% due to – and our guidance were 100% due to changes in FX.

Operator

Your next question comes from the line of Rajesh Ghai with Think Equity. Please proceed.

Rajesh Ghai – Think Equity

Congratulations. One question I had was regarding bio behaviors. As the economy weakens, are you noticing any behavior in terms of customers becoming more circumspect and probably more customers inviting you to deals than you had seen in the past?

Bob Hammer

Clearly, all customers are scrutinizing their budgets a lot more carefully today than they were a year ago, without questions. We also saw fall out. It wasn’t that we didn’t see any fall out. As I mentioned earlier, the fall out we saw was more than covered by increasing funnels and a big enough close rate to mitigate all that, but we are seeing, as one of our guys in the international market put it this way.

He said, you’ve got – a number of his customers are seeing dramatic drops in sales, but their balance sheets are good and they’re focusing on programs that reduce costs and improve operational efficiencies. So, money is freeing up for technology like ours that drive those kinds of results. So, you’ve got a double dynamic going here. I would call it the early stage of this recession. We anticipate that this recession will deepen over the next two or three quarters and as we talked to Tom Curlin, we’ll manage it accordingly, but right now we’re seeing almost the opposite in terms of the growth in our funnels and ability to close. Even though our close rates are down, by the way. Okay?

Rajesh Ghai – Think Equity

Yes and you mentioned something about Dell becoming stronger in FY 2010. What exactly gives you the confidence that Dell could become stronger going forward?

Bob Hammer

No. I think what I said was that the impact of things likes the EqualLogic bundle and the DL2000 impact of those initiatives will be felt in 2010 and we haven’t baked in any impact from those in FY 2009.

Rajesh Ghai – Think Equity

Okay. Thanks.

Operator

Your next question comes from the line of Brent Bracelin with Pacific Crest Securities. Please proceed.

Brent Bracelin – Pacific Crest Securities

Thank you. Bob, clearly it sounds like you had a strong start this quarter, strong close to the quarter here, large deal pipeline looks pretty good. I really wanted to follow-up on smaller deals. If you look at kind of the smaller deals here, it did downtick on an absolute dollar basis sequentially. Not a lot of growth year over year. As you think about the visibility and smaller deals, less than $100,000, are customer’s upsizing those smaller deals and moving more into that larger deal bucket? What are you seeing on those less than $100,000 deal kind of visibility there and the trends you’re seeing?

Bob Hammer

Your stats are absolutely correct, Brent. I think some of that is macro. Some of that is competitive. A lot of it is as a Company, we’ve been almost singularly focused on the enterprise, but we’ve been putting a fair amount of foundation building into SMB and I think you’ll see that over the next 12 months you’ll see that turn, but we are aware of that and I think you’ll see some movement in that. I don’t think – you might see some of it this quarter because the funnels this quarter in the smaller deals looks pretty robust. We’ll see what our close rate looks like, but the funnel growth looks much better.

Brent Bracelin – Pacific Crest Securities

Okay. Thank you.

Operator

Your next question comes from the line of Steve Koenig with KeyBanc Capital. Please proceed.

Steve Koenig – KeyBanc Capital Markets

Hi. Good afternoon. Thank you. Bob or Lou, just wondering, can you help us understand a little bit as we move into next calendar year and beyond the March quarter, what are the factors that could drive margins either up or down from fiscal ‘09? How should we think about that?

Bob Hammer

It’s pretty singular. No pun intended. I mean our models that we have today, if our sales grow faster – I’m not being flip on this, but clearly if we have higher licensed revenue sales growth relative to our expense models, you’re going to see margin expansion. That is absolutely possible. That’s what our models show internally, but given this environment, it’s not prudent for us to – and given all the uncertainties to guide to what we’re seeing internally because we just don’t know enough right now. So, the biggest thing that will change operating margin is a relative increase in the growth of license revenues.

Steve Koenig – KeyBanc Capital Markets

And is that, just a clarification; is that relative to kind of the current rates of growth or relative to some other cut off?

Bob Hammer

No. It could happen this December quarter. It is possible we could grow faster than guidance and if we did, you’re going to see, given our spending rate, you could see some margin expansion and we’re managing this right now. The other thing that could impact margin, that’s the primary one. The other thing that could impact it is FX. You’ve got a negative impact of FX due to – on revenue, assuming you don’t increase prices and we are – there’s a distinct possibility that we will be able to mitigate some of the negative impact on revenues with price increases and you obviously get a positive impact on op expense due to the weaker currencies. The result of the negative FX moves and positives could be, right now we’re assuming they’re going to be negative, but them – we could mitigate a lot of that. That could help.

Steve Koenig – KeyBanc Capital Markets

Okay and I’ll turn it over to the next caller but just – I’ll claim that this is part of the question and ask what allows you to make those price increases in this economy?

Bob Hammer

That’s a really good question. What we try to do is keep the price increases – to keep them modest so that we maintain significant cost reduction advantages for our customers and that’s just – those adjustments are made selectively in each market. So, I’ll give you a better answer on that at the end of next quarter because we’re in the process of implementing those and we’ll have a much better handle. In addition, many of the competitors have risen prices also which is helping. Again, this is on a relative basis. As our value proposition has got to be relative to a customer doing nothing and relative to competitive alternatives and as long as we keep significant comp hold, positive differentiation there, I think we’ll do just fine, but that is not an exact science.

Operator

Your next question comes from the line of David Bayer with Cantor Fitzgerald. Please proceed.

David Bayer – Cantor Fitzgerald

Hi there. Congratulations on a very strong quarter also. I guess we’re all sort of asking a similar question. Maybe I’ll offer a different perspective on it. Given that we are seeing some companies telling IT departments to cut back on their budgets or show no growth budgets or whatever, to continue to have your kind of growth is obviously very, very powerful. I guess I’m wondering to what degree you’re getting feedback that other products are being different so they continue to invest in data or do you think that perhaps we’re seeing a phenomenon of share shift amongst the customers? Just sort of that kind of granularity would be helpful.

Bob Hammer

Clearly, as we look at our results, you always try to understand when you’re doing well, why you’re doing well. When you’re doing poorly, I think we have some sense of that. I think if you really get down to the fundamentals, we’ve got more feet on the street. We’ve got stronger distribution. We’re more effective at selling cost reductions, operational efficiency, value proposition, given the breadth and depth of our suite.

Simpana 7.0 value proposition went up significantly versus our last release and on a competitive front, other than Symantec, the other software competitors have weakened. Net-net, even including Symantec, we’re clearly picking up market share and we’ve been doing that for ten years and everybody continues to ask, "Why?" And it always gets down to having a much stronger value proposition. Again, in this market, you got to focus on cost reduction and operational efficiency versus any old competitive alternative or do nothing. That’s the best answer I can give you right now. I don’t know Al, if you want to jump in on this?

Alan Bunte

I think the only thing I’d add, David, is not only do we sell a better value proposition, but we deliver it and it’s proven out there in many of customers who’s referenced by a strong reference ability and as well, we’ve continued to invest in our support mechanisms.

Bob Hammer

Good point.

Alan Bunte

And again, those are all really viable or important criteria for guys moving forward and making these kinds of purchases. Again, lastly, I think we’re in a category, as you know, David, these are strong TCO savings versus business value improvements. It’s a slightly different application types and I think we’re in a good place given the recessionary environment, I guess.

Bob Hammer

I think in addition, compliance is still an issue out there. So our archiving and search products are growing significantly and that is also helping us.

David Bayer – Cantor Fitzgerald

Very good. Thank you.

Operator

Your next question comes from the line of Derek Bingham with Goldman Sachs. Please proceed.

Derek Bingham – Goldman Sachs

Hi. Congratulations as well. If you’ve got five points of currency in September, what are your assumptions about what you think currency’s going to do as you’ve guided for the December and the March quarters.

Bob Hammer

We’ve taken a big hit on currency, Derek. We understand it. Lou will talk in a second here, but we spend a fair amount of time on this and have been relatively conservative in our assumption on currency on the negative side and those – the currency impact, it’s clearly baked into our model both on the op expense side and the revenue side. So, I don’t know, Lou, if you want to comment?

Lou Miceli

No. I think the point is we understand the significant changes in foreign exchange, particularly in the last few weeks. If I looked at it yesterday or the day before, it was much different than it was at around noon today. So, some of them came back. The honest answer is we don’t know where they’ll go, but we applied the current, more recent foreign exchange rates to our forecast and we did that in the last few days. Literally, we’re working on it up through yesterday and today it changed back, favorable a little bit. So, where it goes tomorrow I guess is anybody’s guess, but we think we’ve applied prudent judgment to it and we’ve factored it in as Bob said, on the top line and on the bottom line.

Derek Bingham – Goldman Sachs

Okay. Just one quick one on margin, when you came into fiscal ‘09 and I think you were thinking maybe you’d get a couple of points of expansion and now, assuming things play out as you’ve guided, we’re closer to flattish. What would you attribute kind of the difference to? Would you say it’s more (inaudible)?

Lou Miceli

Derek, the issue is clearly we didn’t expect a major recession to come in and hit here. We did not expect currencies to take a hit. We were outpacing every Company in our field and, if you would ask that question, it’s a little bit silly. We all know we’re in a major recessionary environment that we didn’t plan on going into this fiscal year and we certainly didn’t expect the impact of currency to hit. Those are the things that we didn’t expect. On the positive side, we didn’t expect to have things like MacAfee come into play.

Derek Bingham – Goldman Sachs

That was my point. Is macro relative to maybe other investment opportunities that you didn’t foresee at that the beginning of the year?

Lou Miceli

Yes. We see additional investment opportunities on the positive side and we ended up into a catastrophic economic situation we clearly did not anticipate.

Derek Bingham – Goldman Sachs

Okay. Thank you.

Operator

Your next question comes from the line of Phil Winslow with Credit Suisse. Please proceed.

Dennis – Credit Suisse

Hi. This is Dennis [ph] for Phil Winslow. Most of our questions have been answered, but can you discuss your headcount expectations as you manage through this environment over the next six to 12 months?

Bob Hammer

Al will take that.

Alan Bunte

Yes, Derek. We anticipate it being probably a little less than what we’ve seen the last couple quarters. I think we’ve been consistent in Q1 and Q2, but we’ll be roughly in that range and the mix, I think somebody asked earlier, in terms of sales and marketing, R&D, G&A, it’s roughly kind of the mix that we’ve been doing in terms of it will be primarily focused on sales and marketing in terms of head count and investments.

Operator

Your next question comes from the line of Tim Klasell with Thomas Weisel Partners. Please proceed.

Tim Klasell – Thomas Weisel Partners

Yes. Hi, guys. Good quarter. First question is on Simpana 8. Can you sort of tell us, will that be a product that will also have a lot of offerings for the ADIM and hence ASPs going up? And if so, are there any changes to the channel that you want to make to help accommodate that?

Bob Hammer

Clearly, Tim, I think you’re right on here. There is a lot of evaluated enhancements that could, we’ll say "could", impact positively ASPs. No question. If you think about things like – just take two, take duplication, block level, and take what we’re doing in virtualized server environments. Those are significant value adds from a customer point of view that could drive ASPs up, but that whole list of things, all of those have potential ASP positive impacts and we’re more confident about it now because we’re in beta and we’re getting customer feedback on that potential value adds. So, typically we wouldn’t bake those into FY ‘09. Those would be baked into our FY ‘10 planning.

Tim Klasell – Thomas Weisel Partners

Okay. Okay and this one’s for Lou. The board has authorized $40 million debt to buy back shares and obviously the debt markets aren’t too friendly right now, but how are you guys thinking about that with all the macro turbulence out there? What is your appetite to take some leverage on the balance sheet should the debt markets thaw a bit?

Lou Miceli

We still have that line available. That’s available to us any time. We haven’t used it and we still have $40 million left on the repurchase program that was approved by the board. So, we still have that possibility going forward. So, the answer is if we wanted to borrow the money that money is still available under a facility we put in place several months ago.

Tim Klasell – Thomas Weisel Partners

Okay. Is there a change in appetite to actually do that right now or is it a little bit more – you want to be a little bit more cautious now?

Bob Hammer

Well, cautious a little bit.

Lou Miceli

Cautious a little bit.

Bob Hammer

That would be the operative word.

Tim Klasell – Thomas Weisel Partners

Okay. Thanks a lot, guys.

Operator

Your final question comes from the line of Joel Inman with Robert Baird. Please proceed.

Joel Inman – Robert W. Baird

Hi. Thanks for taking my question at the end. When you talk about large deals increasing, to what extent would you attribute that to maybe green field opportunities related to virtualization? And what I mean by that is in the past, backup software has been incredibly sticky and hard to get customers out of. Perhaps they have a chance now to kind of evaluate other products in a virtualized environment when they’re redoing everything else?

Bob Hammer

I’ll answer that more broadly and I’ll let Al jump in because he’s a little closer to this issue, but I think clearly having a good platform that we have and the broad suite of products that is sitting on that platform allows us to get into many more opportunities than just backup. As I said, it’s a data management and information management play. It’s in the broader market. That clearly helped us get into the larger enterprise too because the larger and more complex the deal, the more value we have relative to competitor product, a major larger competitor. In regards to virtualization, it’s a catalyst. I’m going to let Al take this because he has been involved in this and I’ll let Al expand on it for you.

Al Bunte

Yes, Joel. We’ve commented on this in the past and I’m not sure if it’s totally enterprise-centric, but it’s definitely on new deals. It’s definitely on guys as they move to a virtualized environment. It tends to kind of bring the light or at least even worsen or make it more of a challenge to the data management environment.

So, it tends to be the next discussion point as people go through and you’re right. It tends to be typically a catalyst there, but as Bob said, I wouldn’t probably characterize it as just that. It tends to be a much broader discussion. It tends to be driven by a whole lot of things. Anything from compliance to poor reliability to poor backup performance. Usually that’s all driven by really poor recovery SLAs or recovery performance. Many people move into more robust disaster recovery environments. We’re seeing current guys really with a push on trying to reduce their tape usage or even tape infrastructure usage. Again, all driven from efficiency and cost perspectives.

Joel Inman – Robert W. Baird

Okay. Thanks a lot

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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Source: CommVault Systems, Inc. F2Q09 (Qtr End 09/30/08) Earnings Call Transcript
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