Guidant Software Inc. Q3 2008 Earnings Call Transcript

Guidant Software Inc. (GUID)

Q3 2008 Earnings Call

November 6, 2008 5:00 pm ET

Executives

Victor Limongelli - President and Chief Executive Officer

Barry Plaga - Chief Financial Officer

Bill Powell - Director, Investor Relations

Analysts

Brian Gesuale - Raymond James

Kevin Buttigieg - Stanford Group

Mark Schappel - Benchmark Company

Phil Rueppel - Wachovia Securities

Keith Weiss - Morgan Stanley

Jonathan Ruykhaver - Think Equity

Presentation

Operator

Good day everyone and welcome to the Guidant Software third quarter earning results conference call. (Operator Instructions)

At this time, for opening remarks and introductions, I would like to turn the conference over to the Director of Investor Relations, Mr. Bill Powell; please go ahead.

Bill Powell

Thank you. Good afternoon, everyone. This is Bill Powell, Director of Investor Relations and we thank you for joining Guidant Software’s third quarter 2008 earnings conference call. In a moment, I will introduce our President and Chief Executive Officer, Victor Limongelli; and our Chief Financial Officer, Barry Plaga, who will present and discuss with you our business and financial performance. Before they begin, I’d like to go through some notes for the benefit of our audience.

Guidance Software reports its results on a Generally Accepted Accounting Principles or GAAP basis in conformity with Security and Exchange Commission standards. These results may differ from results published by analysts or the media featuring pro forma financial results which may not be in conformity with regulatory standards. We encourage everyone to review our financial results presented on a GAAP basis which are detailed in our press release issued today at 4:01 PM Eastern time.

Some of the information discussed on this call, including projections regarding revenue and operating results, may contain forward-looking statements. These statements involve risks and uncertainties that may cause actual results to differ materially from those set forth in the statements.

Additional information concerning these risks and uncertainties can be found in the company’s most recent periodic reports filed with the U.S. Securities and Exchange Commission. Guidance Software assumes no obligation to update any forward-looking statements.

Let me describe the format for today’s call. Victor will begin the call with a review of our third quarter achievements and then provide his perspective regarding where things are headed next. Barry will then follow Victor with a review of our financials for the quarter. Then we’ll open the call to accept your questions and provide answers before ending our call today.

Now, I’d like to turn the call over to the President and Chief Executive Officer of Guidance Software, Victor Limongelli. Victor.

Victor Limongelli

Thanks, Bill. Good afternoon, everyone. I’m happy to report that Guidance Software had a strong third quarter. Although the economic environment was challenging, we performed very well. We delivered revenue of $23.1 million, our best quarter in the history of the company and after excluding share based compensation we earned $0.02 per share in the third quarter of 2008 on a pre-tax basis.

The third quarter was a landmark for us in a couple of respects. First, we introduced the new architectural framework for the products that run on top of our EnCase Enterprise platform; most notably, version 3 of EnCase eDiscovery and the new EnCase Data Audit and Policy Enforcement product.

These products have a much easier to use, workflow driven interface, which will be crucial for the long term, widespread adoption of our technology. The new framework also makes it easier to build and test new products built on the EnCase enterprise platform.

Second, we announced a Pay-Per-Use pricing option for EnCase eDiscovery. As it turns out, that offering enhances our competitive position in difficult economic conditions in which capital budgets are likely to be tighter than normal.

In the third quarter, despite the fact that we did not launch the Pay-Per-Use model until late August, we were very pleased that we were able to sign five customers to the Pay-Per-Use model, including prominent companies such as Verizon and Coke Industries.

Notably, we launched Pay-Per-Use, acquired our first customers under that program and achieved record levels of recognized product revenue for the quarter and interest in Pay-Per-Use has continued to be strong in Q4. As was the case in Q3, we believe the Pay-Per-Use program will on the whole turn out to be mostly additive for us, rather than cannibalizing a significant number of our perpetual deals.

The underlying platform, EnCase Enterprise, continued to perform well in Q3 with 27 new customers in the quarter. In fact, the total of 74 new enterprise customers through three quarters already exceeds the 71 new enterprise customers we had for the entire year in 2007. In other words, we are on track for 100 new enterprise customers this year, which would be up nearly 50% from last year.

Growing our customer base is important for the long-term growth of our business, because we very often sell back into our existing customers. For instance, in Q3, 47% of our enterprise bookings were to new enterprise customers and 53% were to existing enterprise customers.

Overall, we are approaching 600 customers for EnCase Enterprise and we believe the software’s deployed on over 10 million desktops, laptops and servers. This platform gives us an enormous opportunity to continue to add products that serve specific business needs; as we did in Q3, with the successful launch of the new data audit and policy enforcement product and as we are planning later this quarter when we ship our recently announced EnCase Legal Hold product.

Finally, on the product revenue front, I’m happy to report that EnCase Forensic had another strong quarter. It continues to be the gold standard for digital forensics and the roughly 30,000 copies of that product that have been sold reinforce the strength of the EnCase brand and the ubiquity of the EnCase evidence file format.

Our services businesses continue to deliver solid performance. The third quarter is typically seasonally slow for our professional services and training businesses, but our services divisions had strong quarters. Our training division in particular is on track to train over 6,000 students this year, which would be over 25% higher than last year.

In addition, we launched our first online training course in Q3 and we expect to launch a couple more online courses later this quarter. Those courses are important to our overall strategy of increasing the adoption and use of the EnCase Enterprise platform and the products, such as EnCase eDiscovery, that run on that platform.

On the product development front, we continue to invest in R&D. We saw returns on that investment in Q3 with version 3 of EnCase eDiscovery, with the new data audit and policy enforcement product and with the announcement of the new Pay-Per-Use pricing option.

As I alluded to a few moments ago, we have recently announced a new product due out later this quarter, called EnCase Legal Hold, a web based litigation hold and tracking solution that is tightly integrated with EnCase eDiscovery. This integrated solution enables corporate and legal departments not only to identify and notify custodians of legal preservation holds at the outset of litigation, but also to manage, track and report on the actual preservation collection and processing of electronically stored information.

It gives the customer full control over the entire spectrum of the litigation hold process and provides detailed reports regarding the collection and processing of ESI. We expect it to expand and strengthen our value proposition to customers in the electronic discovery arena.

In our last conference call, upon learning about our Pay-Per-Use pricing model, one of our analysts asked if that offering would lead to partnerships with service providers. I’m happy to report that it did. Recently, we have announced partnerships with CACI, a leading contractor for among other things, litigation support to U.S. government agencies and with Protiviti, a global business consulting and internal audit firm. These alliances underscore the value that our technology provides and they represent a new channel for us separate and distinct from our traditional direct sales model.

As we head into 2009, by equipping and enabling these partners with our industry leading EnCase eDiscovery technology, we expect to drive incremental revenue and even wider adoption of our technology.

Let me take a moment to address the economic environment. Obviously, it is challenging, particularly in certain verticals such as financial services, but we are well positioned to perform in this environment for three reasons.

First, we are not dependent on any one vertical. Q3 is an excellent example of this in that we were able to post record revenue, despite only $50,000 in EnCase Enterprise revenue from the financial services vertical in North America. Second, the Pay-Per-Use pricing model is ideally suited to these times. We had no special insight into the economy; we did not introduce Pay-Per-Use because we expected a meltdown of the financial system or a deep recession; however, it offers us the unique ability to engage with and sell to customers who have frozen capital spending or are themselves facing challenging circumstances.

Third, the EnCase Forensic training, professional services, and maintenance revenue streams, in aggregate representing roughly 60% of our revenue, are relatively predictable and stable. They provide a great base of revenue from which to drive the business forward.

Finally, our strategy to drive widespread adoption of our technology by making it easier to use as seen in version 3 of EnCase eDiscovery and easier to buy as seen with the Pay-Per-Use option and the new partnerships with service providers. This strategy is working. We posted record revenue; introduced new products; built deferred revenue and added Pay-Per-Use customers. Despite the terrible economic conditions, we are cautiously optimistic about Q4.

Before moving to the financial portion of our call, let me conclude with two announcements regarding additions to our Executive Team. First, I’d like to welcome Grant Johnson, who joined us recently as Vice President of Marketing. In this role, Grant has worldwide responsibility for marketing strategy and execution. He was previously a Vice President of Marketing at Filenet, which is a division of IBM and prior to that served in executive marketing roles at Front Bridge and Symantec, among others.

Finally, I’d like to welcome Barry Plaga, who joined us recently as our Chief Financial Officer. Barry was formally Vice President of Financial Global Processes at Sun Microsystems and he previously served for six years as Chief Financial Officer of Seebeyond and for two years as Chief Financial Officer of Activision. We’re thrilled to have Barry onboard.

Now, I’d like to turn the call over to Barry for a more detailed discussion of our numbers. Barry.

Barry Plaga

Thanks, Victor. It’s great to be here at Guidance Software. It’s nice to join a company that not only has a great management team and a product that is recognized as the industry standard, but that also has a solid balance sheet and that is poised for growth, margin expansion and profitability.

As a starting point and to be consistent with previous company practices, the financial information provided on this call will be presented on a non-GAAP basis only. Any information we present on a GAAP basis will be noted as such. Please see our third quarter press release for the reconciliation between GAAP and non-GAAP results.

As has been said on previous conference calls, I will discuss out net results on a pre-tax basis given certain tax rates that the company may be subject to. Total revenue in the third quarter of 2008 was $23.1 million, up $2.8 million or an increase of 14% as compared to the third quarter of 2007. Product revenue rose to $12.5 million with a record third quarter and a record best quarter in the company’s history, up $900,000 or 7.7% from the third quarter 2007-product sales of $11.6 million.

Analyzing the components of our product revenues, enterprise license revenues were essentially flat year-over-year at $8.2 million, as compared to $8.3 million in the third quarter of 2007; however, enterprise license revenues increased 16% sequentially from Q2 2008.

We had six enterprise sales that were greater than $250,000 in license revenue and we also sold 19 EnCase Enterprise add-on modules in the third quarter. Included in those 19 modules were 11 eDiscovery, 4 Data Audit and Policy Enforcement, and 4 Information Assurance. As Victor mentioned earlier, our data audit product began shipping in Q3.

The third quarter of 2008 was also a record quarter for forensic product sales, with revenues of $3.7 million up 25% year-over-year. Services and maintenance revenue rose to $10.6 million in the third quarter of 2008, up $1.9 million or 22.5% as compared to $8.7 million in the same period a year ago.

Services and maintenance revenues includes professional services, training and maintenance revenue. Professional services revenues were $3.2 million for Q3 2008 versus $2.6 million in Q3 of the prior year, an increase of 21% year-over-year. This increase is attributable to the strength of our eDiscovery services offerings.

Training revenues were $2.4 million for Q3 2008 versus $2.2 million in the prior year period, showing an increase of 12% year-over-year. Maintenance revenues increased 29% year-over-year to $5 million in Q3, as compared to $3.9 million in the prior year period. This increase is attributable to our enterprise license bookings over the past year, combined with strong maintenance renewal rates from our existing customer base.

Sequentially from Q2, services and maintenance revenues were down 2% in Q3. This decrease was primarily driven by the seasonality of the professional services division, which is impacted each year by a lower level of business in the summer. Sequentially from Q2, training revenues were flat in Q3 and maintenance revenues increased 7%. Geographically, U.S. revenues comprised 84% of Q3 2008 revenues, a higher proportion than in past quarters, while EMEA represented 12% and Asia another 4%.

On a non-GAAP basis, overall gross margin for the third quarter of 2008 was 74% versus 75.2% in the prior year period; however, compared to the second quarter, gross margins improved over 2% from 71.9% to 74%. The decrease in overall gross margins year-over-year was driven by a lower mix of product revenue, 54% versus 57%, combined with a lower margin year-over-year on our professional services business, negative margin of 1.7% versus a positive margin of 1.2%, slightly offset by an increase in year-over-year gross margins of our training business, 45% versus 41%.

On a non-GAAP basis, operating expenses were 73% of revenues in the third quarter of 2008 versus 69% of revenues in the prior year period. Sequentially, non-GAAP operating expenses increased 3.2% to $16.9 million and this increase was driven by higher sales commissions due to the increase in product sales and slightly higher G&A costs for one-time recruiting and severance costs associated with recent management changes.

In terms of company headcount, as of September 30, our full time headcount was 419 employees, up from 407 as of June 30. As the company has previously reported, this is just about our full projected headcount for the year and of course while unexpected turnover can occur, we expect to end the year staffed around this level. As of October 31, for example, we were at 417 full time employees and as we head into 2009, we expect our overall headcount numbers to remain around that level through much of next year.

For the third quarter of 2008, share based compensation was $2.4 million, up approximately $1.4 million year-over-year and up $200,000 from the second quarter of 2008. For 2008, we expect share based compensation expense to be in the range of $8.7 million to $9 million.

In the third quarter of 2008, we recorded a $1.7 million provision for income taxes compared to $983,000 in the prior year period. Our current provision for income taxes is primarily attributable to the company’s change in judgment regarding future realization of its existing deferred tax assets.

We consider whether it is more likely than not that some or all of the deferred tax assets will not be realized. Excluding discrete or one-time items, the income tax provision is based on the company’s best estimate of its annual effective tax rate and taking into consideration the amount of current benefit it can realize, if any.

On a pre-tax non-GAAP basis and excluding share-based compensation, we are reporting third quarter 2008 income of $400,000 or $0.02 per share as compared to pre-tax non-GAAP income of $1.6 million or $0.07 per share in the third quarter of the prior year. On a GAAP basis, we are reporting a net loss of $3.7 million or a $0.16 loss per share, that’s compared to a net loss of $400,000 or a $0.02 loss per share in the third quarter of 2007.

Now turning to the balance sheet, cash and investments decreased $3.6 million from approximately $37.6 million at year-end, to $34 million as of 9/30. For the third quarter, net cash used in operating activities was $2.5 million, which was primarily driven by an increase in our DSOs.

Despite strong collections of almost $21 million during the quarter, our DSOs were impacted by delayed payments by a single customer, a majority of which has been collected during the month of October. As our new CFO, I will be seriously focused on reducing our DSOs.

In the September quarter, we grew our deferred revenues to a record $29.9 million as of September 30. The current portion of our deferens on the balance sheet was $27.2 million which will be recognized over the next 12 months.

As you know, in the third quarter of 2008, our Board of Directors authorized a program to repurchase up to $8 million of our common stock. During the quarter, we purchased 42,500 shares at an average price of $5.91 for a total of $251,000. Outstanding share count as of September 30 was $23.2 million shares, up approximately 61,000 shares from June 30. We expect to end the year with a share count in the range of $23.2 million to $23.4 million shares.

Now, I’ll turn to forward-looking guidance. At the Q2 earnings call this past August, which was before the economic crisis experienced in September and October, we guided a full year revenue range for 2008 of $90 million to $95 million. Given the current economic environment and our good results to date, we expect to be within this range, but most likely in the lower half of that range.

On a pre-tax non-GAAP basis, again fine tuning within a previously given range, we expect EPS for the full year to be in the range of breakeven or $0.00 per share to a positive $0.05 per share.

Let me wrap-up my portion of this call by saying that we executed well in a tough economic climate. I’m looking forward to partnering with Victor and our management team in building shareholder value and translating our growing market share into growing operating margins.

With that, let me turn the call back over to Victor for his comments.

Victor Limongelli

Thanks, Barry. I also want to thank the Guidance employees for their hard work and execution during the third quarter. In particular, we were thrilled by the productivity of our development team and were encouraged by the recent strides made by our sales team and we know we can count on the continued focus and execution of our employees in Q4.

Finally, I’d like to thank our customers, both the 30,000 users of EnCase Forensic and the nearly 600 customers of the EnCase Enterprise platform, who value our dedication and focus on eDiscovery and other digital investigations. Bill.

Bill Powell

Thank you, Victor. Now, we’re open to taking your questions. Operator, would you please tell our listeners how to register their questions and then tell us who our first questioner is?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Brian Gesuale - Raymond James.

Brian Gesuale - Raymond James

I wanted to talk a little bit, not surprisingly about Pay-Per-Use, Victor and maybe as you’ve been out there talking to a lot of customers, maybe tell us a little bit about the receptivity to that and it seems like it’s going quite well. Then I guess a follow-up question would be, you seem fairly confident in the outlook in the fourth quarter. Can you maybe just give us a sense of what that Pay-Per-Use line might look like as people are adopting that? Thanks very much.

Victor Limongelli

Thanks, Brian. Sure, we can talk a little bit about that. There’s been a lot of interest. First of all, we were very happy with Q3 because we launched it. The marketing launch of that was August 20 and being able to sign actually five deals by the end of the quarter we thought was very good and there’s been continued interest in Q4 so far.

The actual release of that technology, version 3.2, just came out last week and we’re just doing the first implementation now this week actually, the first implementation for a Pay-Per-Use customer and those will continue as we move through November and to December. I think the revenue line for Q4 for that is not going to be meaningful in the short run here, but as we go into 2009, obviously we are looking for that to contribute to our revenue performance.

So in short, the customer receptivity has been very good. There are a lot of customers that don’t have capital budgets at the moment, but they’re still interested in solving this problem and in the medium and long term we think it’s going to contribute a lot, but the revenue impact in the short run is not going to be great. Does that cover?

Brian Gesuale - Raymond James

Yes, that’s very helpful and maybe one follow-up on the deferred revenue line. Can you maybe give us a sense on how we would expect to see Pay-Per-Use build in that line over time and then, maybe also give us a sense for how much the Forensics piece was in the deferred line, if you have that information at your fingertips. Thanks.

Victor Limongelli

Yes. I’ll address the Pay-Per-Use piece a bit and I’ll let Barry answer the Forensic piece of it. Pay-Per-Use revenue is going to be recognized as it’s earned, as it’s used, rather than being thrown up on the balance sheet, generally speaking. So we’re going to end up with that coming in on a monthly basis as the cases are going on and people are using it. With respect to Forensic, I think Barry can address that for you.

Barry Plaga

So as of 9/30 on the deferred it was about $10.1 million of the deferred balance.

Operator

Your next question comes from Kevin Buttigieg - Stanford Group.

Kevin Buttigieg - Stanford Group

Victor, you mentioned about how Pay-Per-Use is appealing to customers that don’t have capital budgets. Is there any way that you could tell among these five Pay-Per-Use deals that you did in the quarter if that was the primary reason for them going with eDiscovery or were they otherwise potentially candidates for the license product? Any sense for how the Pay-Per-Use is actually driving those particular transactions?

Victor Limongelli

Yes, sure Kevin. I think if I understand your question correctly, you’re asking what’s the mix between Pay-Per-Use deals that may have turned out to be perpetual otherwise, but went Pay-Per-Use.

Kevin Buttigieg - Stanford Group

Yes, exactly. I’m trying to get a sense of whether the Pay-Per-Use customers are new customers to Guidance or whether they might have potentially been licensed customers for Guidance.

Victor Limongelli

Yes. I think five’s a small sample, but on a whole that they were new customers and we think even in Q4 here, I mentioned on the last call that we were looking to drive up the number of NKC Discovery customers gained in the quarter up to around the 20 mark, which we are still looking to do in Q4 and we think the mix is likely to be 50/50 or 60/40 one way or another. In other words, there are still going to be customers going with perpetual deals, and then there are going to be some that want to go with Pay-Per-Use.

Now, are there some that would have done perpetual otherwise? Maybe, but I think on the whole it gets us in more conversations and we’re also finding that it gets us in a conversation and then the customer is weighing what makes sense for it. Does it make sense for it to do a perpetual deal? Let’s run the math. Does it make sense for us to do Pay-Per-Use? So being in a position where they’re weighing two different alternatives from us, one against the other, is a good position to be in.

Just to comment a little further on that, if you look at the financial services vertical, if right now our only pitch were $1 million perpetual deal to a large financial services company, it would be hard to even get a meeting with a lot of those folks, but having the Pay-Per-Use option gets us in there, gets us in the conversation and I think as I mentioned in the prepared remarks, it’s going to be on the whole additive for us.

Kevin Buttigieg - Stanford Group

Okay, great and then, any comments on how the government performed for you this quarter?

Victor Limongelli

Yes, we had a solid Q3 from the federal space. You may know there’s a continuing resolution again that’s not affecting DHS, Department of Homeland Security; it’s not affecting DOD, but it is affecting other civilian agencies. Although with the new administration in place in January in the new Senate and House, presumably budgets will be able to be passed and that will go away; overall though, a good quarter in the governance space.

Kevin Buttigieg - Stanford Group

Okay and then just finally, obviously you had the sales in place; could you talk about any sort of changes to the sales management process that may have taken place during the quarter and then corollary to that, I know Barry you’ve been there not to long right now. Could you talk a little bit about what your future plans are for perhaps some changes on the finance management side of Guidance?

Victor Limongelli

Sure, Kevin. I’ll take the sales part of that and then Barry can jump in on the finance side. On the sales side, we did have some sales management change in early July. We have also obviously changed the sales model or at least an option for the sales team with the Pay-Per-Use model. So I would say the focus on that team is on driving activity, getting customers and expanding in customers once we do that, rather than going for the big hit or the big score, which might have been an approach you would have seen in the past.

Barry Plaga

So yes, on the finance side, here in my first week and things are going pretty well so far; I think one of our top priorities is first where Victor may have talked about this earlier in the year as our Oracle implementation that’s going live in January and that’s on track. So that’s one of my high priorities to make sure that happens, because that’s where we’re going to really kind of automate a lot of our business processes and hopefully drive a lot of manual things out of the system and drive down our G&A costs that way .

It will also help with our audit fees and out other external kind of SOX fees, etc to get on this new system, but one of my number one priorities is focusing on expenses, focusing on DSOs, bringing down the receivables and helping with those processes around the company in terms of how do we help the sales force sell more efficiently and close deals quicker, while at the same time managing the rev rec process and bringing the time it takes to close the book down dramatically here over the next six months. So that’s some of my early priorities.

Operator

(Operator Instructions) Your next question comes from Mark Schappel - Benchmark Company.

Mark Schappel –Benchmark Company

To start off with you Victor, were there any big deals in the quarter that would be deals over $1 million?

Victor Limongelli

As in past quarters, we report the over 250 without getting into the outliers that may or may not occur. I think Barry reported in his prepared remarks that we had six over 250; so there were some good size deals. We also had a good number of deals, the 19 product suites that run on the EnCase Enterprise platform, which was pretty solid and 27 new enterprise customers in Q3, which likewise was a pretty solid number.

Mark Schappel - Benchmark Company

Okay and the six mid-size deals, were the bulk of those in the government sector?

Victor Limongelli

I’m trying to remember. There was at least two in the government sector, so I think it was four commercial, two government. A little color on the commercial sector, first I mentioned the financial services vertical; no surprise to anyone on this call, that was a difficult environment in September and October for that matter and so that vertical really did not contribute meaningfully to Q3.

We had $50,000 in financial services revenue out of North America in Q3. So that was a little surprising, but one of the nice things about our business is that we do sell into many verticals and so on the commercial side we were able to pick up that in other areas.

Mark Schappel - Benchmark

And just one final question; with respect to the mid-size deals that fell out of the second quarter, have most if not all of those deals been signed yet?

Victor Limongelli

No. One large deal we were expecting was in financial services and we were expecting it in Q3 and it was on track and negotiated and things sort of fell apart in that vertical. We were overall pleased with the way things turned out though, because we were able to execute in other areas and make up for it. So in that line in particular, if a deal didn’t close in Q2 and you got to September, you were in a tough spot given what was going on in the marketplace and in the world then and we were no different than anyone else in that respect.

Operator

Your next question comes from Phil Rueppel - Wachovia Securities.

Phil Rueppel - Wachovia Securities

One additional question on the Pay-Per-Use product; you mentioned that it just started shipping but you’ve already started implementing. How long will the typical implementation cycle be? Will it be much faster than a perpetual licensed enterprise deal and I know you mentioned to expect a little revenue, but do you think you’ll be running a case through the Pay-Per-Use, one of your five customers this quarter?

Victor Limongelli

Yes. The implementation will be within a couple of weeks, eight days specifically, business days and it’s certainly capable of doing that. Unlike a perpetual deal when you ship it and you have the revenue, it’s somewhat dependent on what litigation they have and what cases they run through it. So if someone gets implemented in November, they may have a lot of litigation in December and it ends up generating revenue or they may not have much until next year. The short answer is we don’t know how that’s going to turn out, but it certainly could. Does that answer your question?

Phil Rueppel - Wachovia Securities

Yes, thanks and building on what you just said about sort of volume of litigation, one of your competitors or at least one of the service providers in the eDiscovery space, echoed what you said about weakness in financial services, but also talked about negative trends and litigation in general just because of the environment. Is that something you’re seeing, and do you sort of have to see a bounce back in that to close any of the deals that are in your pipeline for Q4?

Victor Limongelli

Yes. I think that would affect a service provider more so than someone like us who’s providing software to companies or to service providers and we always see a drop-off on our eDiscovery services business, in our professional services group in the summer and this year was no different.

I know that some of the service providers have commented that they saw people kind of frozen as to what to do in September and we certainly saw that as I mentioned, in the financial services market, but overall we’ve got a lot of interest from people on this Pay-Per-Use and I think they either have litigation or they are going to have litigation and it’s a way for them to get into the product at a low price point and then the other piece for us is opening this up to some service providers to gives us another channel as well; so far we haven’t seen a big impact there.

With respect to the election and the administration change, there’s been some commentary as well in the press. One of the Wall Street Journal blogs had a posting the other day about perhaps increased litigation or regulation coming in ‘09. Certainly, we don’t know if that’s going to happen or not, but for our business in particular, more regulation, more enforcement of existing laws and regulations and more litigation is generally a favorable trend longer term.

Phil Rueppel - Wachovia Securities

Yes, okay great and then a final question from me. You mentioned longer term you anticipate sort of about half the new customers Pay-Per-Use, half perpetual. How long will it be before your pipeline starts to reflect that? I assume sort of going into Q4 a majority of your pipeline is still perpetual deals. How long before the sales force sort of reflects what will be potentially the roughly even split?

Victor Limongelli

Yes, that’s a good question, Phil. When we talked to you last time in August, the difficult for us was we were introducing this and we didn’t really know how it was going to work out. Is everyone going to go Pay-Per-Use, is everyone going to stay perpetual or is it going to be a mix?

So far, we’ve seen a mix in Q3 and it looks like Q4 based on what’s closed and what’s in the pipeline; it looks to be a pretty good mix as well. Longer run, is that mix going to stay the same or not, we don’t know yet. We do believe that there will be customers who go Pay-Per-Use now.

In our capital in ‘08, for instance, they go with the Pay-Per-Use deal and they’re running it every month, they know how to run the technology, it’s implemented, they have someone who knows how to operate it, and they later decide to go perpetual, that may happen as well. So there may be movement back and forth; well, maybe not back and forth, but from Pay-Per-Use to perpetual even within the customer base as we move through ‘09.

So the short answer is it looks to be 50/50, 60/40 right now and we’ll just have to see as we move through the quarters.

Operator

(Operator Instructions) Your next question comes from Keith Weiss - Morgan Stanley.

Keith Weiss - Morgan Stanley

I was wondering if you could talk a little bit about seasonality in the quarter, because it definitely seems like overall conditions got much worse in September and then maybe if you could talk a little bit about what you guys are seeing in October for enterprise spending from customers or from vendors like Cisco. We’re talking about a pretty abysmal environment out there in October, so I was just wondering if we could get your point of view, give us some sense to what your pipeline is looking like going into the fourth quarter.

Victor Limongelli

Sure. So you’re asking I think about linearity within the quarter.

Keith Weiss - Morgan Stanley

Yes and then, how October is shaping up so far.

Victor Limongelli

Okay. So we had a fairly typical quarter for our enterprise license revenue and that the bulk of it came in September. Obviously, we were impacted; we expected some revenue in the financial services vertical; that’s typically 14%, 15% of our enterprise revenue and September was a very rough month in that vertical, but it wasn’t too dissimilar. Most of the deals came in September.

So far in October, we haven’t seen obviously the financial services vertical magically turn around and obviously the overall economic environment, even outside of financial services is weak, but as I mentioned earlier, one of the strengths is our broad based appeal.

We’re not dependent on any one vertical; we sell into biotech and pharmaceutical technology, retail, energy, manufacturing, so that helps in times like these. I would say October went okay, especially given what was going on in the world around us.

Keith Weiss - Morgan Stanley

If I could perhaps squeeze one last one in. The financial service tends to be as you’re saying around 15% of your revenues. Is there any particular vertical that offset that, because obviously it didn’t come in for you guys or anybody? Was there anything in particular where you saw a particular strength in the quarter, any vertical?

Victor Limongelli

Well, government did pretty well, although I don’t think it was out of the ordinary compared to last year and we were able to make progress in other regions and I say other regions, because the financial services doesn’t have to be in the northeast, but our other regions with a mix of different customers did pretty well. So I don’t know that there’s one in particular that I would point to, but it certainly wasn’t financial services in Q3. That hasn’t turned around in financial services market.

We have some Pay-Per-Use interest and good conversations there, but there’s not a lot of capital spending going on in that vertical right now.

Operator

Your final question comes from Jonathan Ruykhaver - Think Equity.

Jonathan Ruykhaver - Think Equity

Can you give a feel for the mix within license revenues between the core of EnCase Forensics product and the EnCase Enterprise?

Victor Limongelli

Sure. EnCase Forensic was $3.7 million I think, and $8.2 million I think for Enterprise.

Barry Plaga

Right.

Jonathan Ruykhaver - Think Equity

Okay and again looking at the EnCase Forensics business, what do you think the impact on that business might be given the constraints out there on the part of state budgets?

Victor Limongelli

Hard to tell. It did very well in Q3 and has done well really all year, so it’s outperformed this year. Every time we think it might drop off it continues to be strong; some of that coming internationally. The spread of Forensics around the world continues. Even in our forecast we had expected some flattening in that product line, but it’s continued to do really well.

Jonathan Ruykhaver - Think Equity

Is a lot of that in the U.S. funded out of state budgets from law enforcement agencies?

Victor Limongelli

Sure. Some of it will be state budgets for law enforcement agencies, some of it will be consulting businesses and some of its international law enforcement and government agencies.

Jonathan Ruykhaver - Think Equity

Okay, so there is some diversity there from an end customer standpoint.

Victor Limongelli

Oh, there’s a lot of diversity there. I mean, just to give you an example, we mentioned 30,000 copies of that. I think there are over 1,000 copies in China; the Korean National Police are standardized on EnCase; the Brazilian Federal Police are standardized on EnCase; it’s very widely used in the U.K., etc, etc, etc. It is really the standard for computer forensics and in fact the EnCase Evidence File which started with that product, is really ubiquitous within that market and also within the eDiscovery market.

Jonathan Ruykhaver - Think Equity

And curious, how are you going about incenting your sales reps on the usage model and should we expect any kind of pressure on gross margins, given that the potential differences in timing between when commissions might be paid out and when the revenue starts to trickle in?

Victor Limongelli

Yes, that’s a good question, Jonathan. We did a couple things with respect to our sales reps for the remainder of ‘09. Number one, if we get a deal where the customer makes a long-term commitment of a significant dollar amount, then a portion of that commission would be paid upfront to the reps, so sort of what you’re alluding to.

The second thing we did was to put some bonuses in place if an individual rep signs multiple customers up before the end of the year and if that customer is implemented by the end of January, because the implementation of course is key with this model, because we don’t see any revenue until the implementation is done and they start using it.

So we did a few of those things. We haven’t seen a big hit yet and if we did, it would be a huge boon because we would’ve closed many, many, many new customers to have a material impact. So we structured it that way because obviously we wanted to incentivize our sales force to make money there or to make money on perpetual.

Jonathan Ruykhaver - Think Equity

Okay. So put at a near term pressure, but actually it would reflect a good development in the business. Just so I understand that that commission or bonus would be paid out after the implementation is done; is that right?

Victor Limongelli

That’s right. It’s only earned if the implementation occurs by the end of January. If we close a deal in December and implementation occurs in March, then the deal doesn’t count for that.

Barry Plaga

And this is Barry and I think some of that upfront commission cost would probably be offset by a shorter sales cycle, so that the sales rep should be able to work multiple deals at the same time where they tend to get embroiled in these longer perpetual deal negotiations. These should go quicker and they should be able to have a lot more customer acquisitions in a shorter period of time.

Jonathan Ruykhaver - Think Equity

Yes, it’s a higher volume business obviously. Okay, well that’s good and then, just a final question. Any kind of commentary around the partnership with Howrey or is it just still too early in that relationship?

Victor Limongelli

So far it’s been good. We had one pretty good size deal that came in, in Q2. We had a large services engagement with Howrey. I was actually in D.C. last week speaking with a number of their partners and we’re moving forward. We’re actually installing the latest version of EnCase eDiscovery at Howrey in the near future and we think it’s a real positive for us.

It provides good validation, the defensibility and reliability of EnCase eDiscovery. We believe it makes a positive impression counsel that we have that relationship and they also help us with some customers and also some services work. So, so far it’s been positive.

Operator

And we have no further questions in the queue. I’d like to turn the conference back over to Mr. Powell for additional or closing remarks.

Bill Powell

I’d just like to say thanks very much to everyone for tuning in today. We appreciate your interest and ownership of Guidance Software and we’ll talk with you again next quarter. Thank you and good day.

Operator

That does conclude today’s conference. We do thank you for your participation.

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