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Executives

Rasmus van der colff - Former Chief Accounting Officer, Vice President and Corporate Controller

Victor T. Limongelli - Chief Executive Officer, President and Director

Barry J. Plaga - Chief Financial Officer

Analysts

Mark W. Schappel - The Benchmark Company, LLC, Research Division

Hendi Susanto - Gabelli & Company, Inc.

Guidance Software (GUID) Q1 2013 Earnings Call May 2, 2013 5:00 PM ET

Operator

Good afternoon. My name is Ben and I will be your conference operator today. At this time, I would like to welcome everyone to the Guidance Software 2013 First Quarter Earnings Results Conference Call. This call is being recorded.

At this time, for opening remarks and introductions, I would now like to turn the call over to Rasmus van der colff, Vice President, Finance and Chief Accounting Officer.

Please go ahead.

Rasmus van der colff

Thank you, Ben. Good afternoon, everyone, and thank you for joining us today to discuss Guidance Software's first quarter 2013 results. With me today are Guidance's President and CEO, Victor Limongelli; and Chief Financial Officer, Barry Plaga.

We would like to remind everyone that during today's conference call, management will make certain forward-looking statements regarding the future operations, opportunities or financial performance of Guidance Software within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. These statements involve a high degree of known and unknown risks and uncertainties that could cause actual results to differ materially from those to be discussed. Please refer to the risk factors and other disclosures contained in the company's most recent reports on Forms 10-K, 10-Q and 8-K filed with the Securities and Exchange Commission for a more detailed discussion of the factors which could affect results to differ materially.

The forward-looking statements made in today's conference call are based on information available as of today, May 2, 2013, and Guidance assumes no obligation to update such statements to reflect events or circumstances after today's date.

Additionally, unless otherwise noted, we will discuss non-GAAP results during today's call. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to the most directly comparable GAAP results, which can be found in today's press release and on our website.

Lastly, before we begin, I would like to remind everyone that today's call is also available via webcast through our Investor Relations website, and a replay will be available on that site.

With that, I would now like to turn the call over to Victor Limongelli, our President and CEO. Victor, please go ahead.

Victor T. Limongelli

Thanks, Rasmus. Good afternoon, everyone. For the first quarter of 2013, our revenue was $27.2 million, up 4% year-over-year. Our first quarter results did not meet our expectations for 3 primary reasons.

First, in addition to the normal seasonal slowness in the first quarter, it was more difficult to get deals done in the quarter and we saw a number of deals slip until later in the year. As customers seemed hesitant to spend, especially on larger deals.

It may be that this was a one-time occurrence and activity will return to normal in this quarter and subsequent quarters. However, in our view, it would be more prudent to assume that this customer behavior will continue this quarter, at least, with demands pushed into the back half of the year, which is typically seasonally stronger for us.

Second, the federal sequestration affected us negatively in a variety of areas, including product sales and training, and that impact, we can only assume, will continue into this quarter and next.

Third, we have been hard at work developing a new product on our EnCase Enterprise platform and ramping up our sales and marketing capabilities. We expect that our focus on future growth will have long-term benefits for our shareholders. But in the short-term, in particular Q1 and Q2, that long-term focus does not aid our immediate results.

So that there is no confusion, our disappointing quarter was not the result of any weakening of our competitive position which remains very strong. And we believe our competitive position is about to get even stronger as we prepare to expand our product set.

Speaking of the new product, as we have said before, Our strategy is to place EnCase Everywhere and to build higher-value products on top of the EnCase Enterprise platform. Our approach has been to invest in research and development and to launch at least one new or significantly expanded product per year. This year, we will launch an entirely new product, a third offering on the EnCase Enterprise platform, to join our current EnCase eDiscovery and EnCase Cybersecurity offerings. This new product, targeted at the IT security market, will be unveiled at our CEIC Conference in a few weeks and we expect it to be generally available in Q3.

Without giving away too many details, I think it's fair to say that it will provide unprecedented visibility and situational awareness to organizations concerned about advanced security threats.

We have been ramping up investment in both R&D and selling and marketing in advance of the launch, so that we can grasp the opportunity in front of us and position the company for further growth in 2014.

With over 40% of the Fortune 500 on the EnCase Enterprise platform, as well as a growing base of EnCase Cybersecurity and EnCase eDiscovery customers, we believe we are well-positioned to provide another high-value product to our core IT security customer base.

As we prepare to launch this new product, I'd like to talk about 3 competitive advantages that we have in the execution of our long-term strategy.

First, although we had difficulty in closing large deals, we had success in Q1 in the execution of our EnCase Everywhere strategy as we added 65 new customers on the EnCase Enterprise platform in the first quarter. Our goal is to make the EnCase platform a standard part of the infrastructure at every organization of 1,000 employees or more.

Earlier this year, a market research firm, the 451 Group, published a security management technology roadmap detailing security professionals' adoption plans for 13 technologies, including computer Forensics and eDiscovery.

Not surprisingly, EnCase was far and away the market leader in Forensics, confirming the continued success of our EnCase Everywhere strategy and was in the top 2 in eDiscovery.

Second, the EnCase platform is an open platform, unlike competitors who maintain closed systems. Last quarter, we launched EnCase App Central, a marketplace in which customers can obtain add-on applications, some free, some paid, to run on EnCase and extend its functionality and increase its value.

With 50 apps currently available and more to come, EnCase App Central underscores the open nature of the EnCase platform, which we believe is attractive to customers now and will be increasingly important going forward.

Third, we have a platform strategy, not a point solution or a series of point solutions. Each of our Enterprise products leverage the same components, the same end-point agents for desktops, laptops and servers. This enhances our appeal when customers are selecting our EnCase Enterprise platform and increases the likelihood of up-sell and cross-sell in the future.

It is an ambitious strategy, covering a broad swath of capabilities, including computer Forensics, eDiscovery, incident response and data discovery, but we believe that we have the pieces in place, including a strong brand name in EnCase and a growing awareness of the need for our technology to execute successfully on our strategy and deliver strong growth and shareholder value in the second half of this year, in 2014 and beyond.

As I said, our first quarter results did not meet our expectations, however, we believe that we are making the right investments to expand our product set, expand our distribution and grow our business in the second half of 2013 and next year.

Now let me turn the call over to Barry to discuss our specific financial results. Barry?

Barry J. Plaga

Thank you, Victor. As a reminder, 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.

Total revenues in the first quarter of 2013 increased 4% year-over-year to $27.2 million, up from $26.2 million in the prior year.

Product revenue in the first quarter was down year-over-year to $7.5 million. Within product revenue, Enterprise revenues were down 37% year-over-year, while Forensic product revenues were down 23% year-over-year.

On the Enterprise side, there wasn't any territory that outperformed, for instance, federal suffered from the sequester, and in North America, although we did well in gaining new customers of the EnCase Enterprise platform, for larger deals, our commercial customers were showing no signs of urgency to spend their budgets early in the year.

On the Forensic side, again, the federal sequestration impacted both EnCase Forensic and Tableau product sales. Subscription, or SaaS, revenue from CaseCentral for the first quarter was $2.8 million, flat with Q4.

Total services and maintenance revenues were up 18% to $16.9 million in the first quarter of 2013, versus $14.3 million in the prior year.

For Q1 2013, we saw a 7% year-over-year increase in maintenance revenue and a 34% year-over-year increase in professional services revenue.

Our professional services group performed well this quarter as it did in Q4, with continued follow-on casework and incident response work with existing customers.

Geographically, in Q1, North America represented 79% of revenues, while EMEA was 13% and the rest of world, 8%. Gross margin for the first quarter was 67%, versus 72% the prior year. The gross margin on product revenue was 77%, down from 84% in the prior year, due to a mix shift in software and hardware products year-over-year.

Gross margins are down year-over-year primarily due to the year-over-year decrease in Enterprise and Forensics software revenues, which carry a gross margin of 90%.

Total operating expenses increased year-over-year to $22.1 million in Q1 from $18.2 million in the prior year. The increase was primarily due to increased headcount in R&D and sales and marketing, as well as having a full quarter of CaseCentral in Q1 this year.

We are reporting a first quarter 2013 net loss of $3.9 million or $0.15 per share, as compared to net income of $600,000 or $0.02 per share in the first quarter of 2012.

We ended the quarter with a solid balance sheet, with cash and cash equivalents at March 31 of $26.1 million, compared to $32.6 million at December 31.

The sequential decrease in cash was driven primarily by capital expenditures of $3.9 million, which included the leasehold buildout of our new consolidated headquarters and the go live of EnCase App Central. Cash used in operations in Q1 was $2 million, which is consistent with Q1 of the prior year, and total deferred revenues were $42.9 million at March 31, a sequential decrease of $600,000 when compared to December 31, but seasonally in line with our expectations.

I would now like to discuss forward-looking guidance. Given the constraints of the federal spending environment and what is expected to be a very back-end loaded year in the corporate sector, the company is revising it's guidance for the year-ended December 31, 2013 as follows: revenue for 2013 is expected to be in the range of $133 million to $138 million; by fiscal quarter, we expect Q2 to be up sequentially a few percentage points from Q1; for Q3 to be up sequentially, approximately 30% from Q2; and for Q4 to be up approximately 20% from Q3.

In terms of year-over-year, that means Q2 would be down approximately 10% year-over-year; Q3 would be approximately flat year-over-year; and Q4 would be up approximately 15% to 20% year-over-year.

We expect gross margins to trend up throughout the year with Q2 being flat with Q1, and then trending up towards 75% to 77% in Q4, and overall, 71% to 72% for 2013.

R&D as a percentage of revenues was 18% in 2012 and is expected to be in the 20% to 21% range for 2013 as a whole, but about 15% to 17% in Q4, trending down as a percentage of revenues as we progress through each quarter this year.

On the sales and marketing side, we have made some progress in opening up new territories overseas and expanding in the U.S. and hiring will continue into Q2 and into Q3.

Sales and marketing as a percentage of revenue is expected to be 30% -- 35% to 37% of revenues in 2013. Again, 35% to 37% of revenues. Trending up in Q2 and Q3 and then seeing some leverage down to approximately to 31% to 32% in Q4. We are still on track to grow our quota carrying sales force from 55 to 60 professionals in 2012, to 70 to 75 sales people by the back half of 2013. We expect G&A for 2013 to be flat with 2012 at approximately 13% of revenues.

Non-GAAP pretax earnings for 2013 are expected to be in a range of a $0.20 loss per share to breakeven or $0.00 per share.

By fiscal quarter, we expect to show a loss in Q2 to be approximately breakeven in Q3, and to return to profitability in Q4.

With that, let me turn the call back over to Victor to conclude our prepared remarks.

Victor T. Limongelli

Thanks, Barry. Although revenue was up and deferred revenues are strong, we were not satisfied with our first quarter results. However, our R&D team is hard at work enhancing our product set in creating a platform of products that corporations and government agencies will increasingly view as must-have technology.

Indeed, in just a few weeks time, we will showcase our new product at our CEIC Conference in Orlando, and we are investing at sales and marketing capacity now, so that we can deliver on our growth expectations in the coming quarters. We look forward to meeting or exceeding those expectations as we execute on our long-term strategy, and in doing so, deliver value to our shareholders.

With that, let me give the call back to Rasmus.

Rasmus van der colff

Thank you, Victor. Operator, would you please open the call to questions?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today comes from the line of Mark Schappel of Benchmark.

Mark W. Schappel - The Benchmark Company, LLC, Research Division

Victor, I didn't catch all of your prepared remarks, I've got a couple of different earnings calls going this evening, but I just want to address the issue of sales force growth during the coming year here and your plans for that. Why grow the sales force so aggressively when you're seeing demand falling?

Victor T. Limongelli

Well, mark, it wasn't so much that the demand disappeared. We had quite a few of opportunities that the customers are indicating they're interested in the product set, that they have budget for the year. But there was, really, seem to be a hesitancy to close deals. So we saw a lower close rate than we have seen previously with regard to the pipeline. We have seen the pipeline grow here in Q2 but we're -- after seeing that one quarter, I know that some other companies have seen similar results and are expecting it all to bounce back immediately in Q2, but I'm not sure that's going to be the case.

So we're trying to be prudent about our expectations and assuming that some of that hesitancy continues at least into the back half of the year. In terms of the sales force growth, we have, we believe, a big opportunity in the cyber security arena and we'll have a new product coming out and we think it makes sense to grow the sales force in advance of, or as we're launching that product rather than trying to launch it and then some point in the future, 1 year or 2 down the road, try to grow the sales force.

Mark W. Schappel - The Benchmark Company, LLC, Research Division

Okay. And then on the CaseCentral business, if I recall correctly, one of your plans was to kind of refocus that business from law firms to corporations or companies. I was wondering if that shift is still ongoing or if it's basically complete.

Victor T. Limongelli

No. It's still ongoing. We did have some legacy one-off cases from law firms that have settled or ended which pulls down the revenue, but we also did gain some new corporate customers recently, just in the last few months and definitely, corporations and not law firms, are the focus of the business now. We have bundled the host and review capabilities with EnCase eDiscovery, and in fact, we changed the name from CaseCentral to EnCase eDiscovery Review now. So we've adopted a more traditional SaaS approach of aiming to add users and then build the business up over time. And we are gaining some corporate customers.

Mark W. Schappel - The Benchmark Company, LLC, Research Division

Okay. And, Barry, do you have the Forensics revenue? I didn't catch that number.

Barry J. Plaga

Yes. For Q1 it was $5 million for the quarter.

Mark W. Schappel - The Benchmark Company, LLC, Research Division

$5 million?

Barry J. Plaga

Yes.

Mark W. Schappel - The Benchmark Company, LLC, Research Division

And with respect to the Forensic side, you mentioned that sequestration was an issue there. I was wondering if -- Victor, if you could just give an example or 2 of what you saw during the quarter?

Victor T. Limongelli

Yes. So obviously, that kicked in, in March. And just to give you an example, if you look at our training business, had very strong January, very strong February, and then in March, had a big number of, on the federal side, of customers cancel their classes or convert, in some cases, to the on-demand offering because they weren't allowed to travel and couldn't incur any expenses that way. So that suppressed results there, with respect to training. And also, with our Forensic product and Tableau products. There was a lot of uncertainty in the federal market as to how much they could spend or what their cuts would be like. Or in some cases, people concerned about their jobs and focused more on that. Federal employees, focused more on that, than normal procurement. Obviously, that situation, the sequester, has continued into Q2 and for the foreseeable future, so we've taken that into account into our overall guidance for the year.

Operator

[Operator Instructions] Our next question comes from the line of Hendi Susanto from Gabelli & Company.

Hendi Susanto - Gabelli & Company, Inc.

So, Victor and Barry, in light of weaknesses in federal government, would you remind us how much revenue comes from that segment?

Victor T. Limongelli

It's about 20% of our revenue, which actually is a lower percentage of -- compared to -- federal is a larger percentage of GDP, than of our revenue, but it is an important part of our business, 20% of our revenue, roughly.

Hendi Susanto - Gabelli & Company, Inc.

20%? Okay. And then September quarter is seasonally stronger government and then considering the current sequestration issue and uncertainties, would you, like -- would you think that September quarter will be weaker than historical as well?

Victor T. Limongelli

Well we kind of -- we factored that in. And Barry wanted to detail on the seasonality this year, because it could be a little bit different than we normally have seen. So what we are expecting, we -- so we didn't -- we've factored that into our guidance in the following way: we're assuming that the customer behavior and the macro weakness that we saw in Q1 will continue, at least into Q2, although on the corporate side, customers seem to be have their budgets and planning to spend it, we just think it's going to fall a little bit later in the year than normal; offsetting that Q3 may be weaker than normal in the federal sector, so if you look at the seasonal -- the seasonality that Barry outlined in his remarks, we're expecting Q3 to be up strongly from Q2, sequentially, like 30% but it may be flattish year-over-year; and then Q4, we're expecting to be up significantly, both sequentially and year-over-year, and Barry detailed that in the guidance.

Hendi Susanto - Gabelli & Company, Inc.

Okay. And then product gross margins are lower than last year, could you share some gross margin dynamics there in light of the current situations and whether you have to do, like, unusually larger discounting in the quarter?

Barry J. Plaga

No. We didn't -- it really wasn't a matter of discounting. It was really the mix of Enterprise and software revenues related to Forensics, versus our hardware products. So typically, on a quarterly basis, our Tableau products have been around 23% of product revenue, this year, they were almost 30% of Q1's product revenue, and that definitely impacted the gross margin on product revenue by about 5 points.

Hendi Susanto - Gabelli & Company, Inc.

And then, I guess, it's reasonable to assume that you won't do any, like, unusual discounting as well for Q2?

Barry J. Plaga

Correct.

Hendi Susanto - Gabelli & Company, Inc.

Okay. Yes. Barry, could you break down the guidance in terms of where the subscription revenue for the year?

Barry J. Plaga

Yes. We're looking at about $11 million to $11.5 million.

Hendi Susanto - Gabelli & Company, Inc.

Victor, where is guidance for the road map in terms of predictive coding?

Victor T. Limongelli

Hendi, that's an excellent question. Predictive coding, we think, is ultimately going to be important to corporations although right now it's more used in the law firm and the service provider market. We have some technology that we're developing that we think will exceed current capabilities that are out in the marketplace, although we're not ready to display them. We've talked to customers about it and some analysts about it, but it's not something that we're ready to publicize yet, but we're definitely working on that on the R&D front.

Hendi Susanto - Gabelli & Company, Inc.

Okay. And then if you look at law firm as a composition of your total revenue, like, what will the composition looks like?

Victor T. Limongelli

Law firms have traditionally been a small part of our revenue. When we did the CaseCentral acquisition they became a somewhat larger part because they had some law firm business. But in terms of percentage of our revenue, Barry, I don't know what -- it would be low-single digits.

Barry J. Plaga

Yes, it's very low. It's not very impactful to the [indiscernible] base.

Hendi Susanto - Gabelli & Company, Inc.

And, Barry, any guidance on what tax look -- will look like this year, going from Q2, Q3 to Q4?

Barry J. Plaga

Yes, it'll be probably about $50k, $60k a quarter. It's going to be very tiny in terms of effective tax rate. So overall for the year, I'd say it's about $200,000.

Hendi Susanto - Gabelli & Company, Inc.

Okay. And then any guidance on CapEx?

Barry J. Plaga

CapEx in Q2 will still be, given the build out on the new consolidated Pasadena headquarters, and that's just wrapping up this quarter, so it will be probably a couple of million higher than it was last year in Q2. So probably, $3 million to $4 million total and then Q3, Q4, it's going to taper off. I don't think we'll be spending a lot in CapEx in those quarters.

Hendi Susanto - Gabelli & Company, Inc.

And then any number for Q3, Q4?

Barry J. Plaga

Yes. I'd say $1 million per quarter after that, that's probably pretty safe.

Hendi Susanto - Gabelli & Company, Inc.

$1 million increase?

Barry J. Plaga

No. Just overall dollars.

Operator

[Operator Instructions] And with no further questions in queue, I'd like to turn the conference back over to Mr. van der colff for any closing remarks.

Rasmus van der colff

Great. Thank you, Ben. This is -- we would like to conclude our call and we'd like to thank everybody for joining us today.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may all disconnect. Have a great rest of the day.

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