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KEYW Holding Corporation (NASDAQ:KEYW)

Q4 2013 Earnings Conference Call

February 4, 2014 5:00 p.m. ET

Executives

Leonard E. Moodispaw – Chairman & Chief Executive Officer,

John E. Krobath – Chief Financial Officer & Executive Vice President

Chris S. Fedde – Executive Vice President

Chris Donaghey – VP of Corporate Development and Communication

Analysts

Brian Kinstlinger – Sidoti & Company

Steven Cahall – RBC Capital Markets

Mark Jordan – Noble Financial Group

Tobey Sommer – SunTrust Robinson Humphrey

James McIlree – Chardan Capital Markets

Josh Sullivan – Sterne, Agee & Leach

Patrick McCarthy – FBR Capital Markets

Jeff Osher – Harvest Capital

Jared Johnson - SG Capital Management

Operator

Good day, ladies and gentlemen, and welcome to the KEYW Fourth Quarter 2013 Financial Results Conference Call. At this time all participants are in listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this call is being recorded.

I would now like to introduce your host for today’s conference, Len Moodispaw, Chairman and CEO of KEYW. Please begin.

Leonard Moodispaw

Thank you and welcome, everybody. As usual, we’ll start with the disclaimer and I’ll ask Jen from our legal department to read that for us. Jen?

Unidentified Company Representative

Under our Safe Harbor disclaimer, statements made in today’s call that are not historical facts are considered forward-looking statements and are made pursuant to the Safe Harbor provisions of Federal Securities Laws. Actual results may differ. Please see today’s press release and our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated results.

Leonard Moodispaw

Thank you, Jen. I will make some comments. John Krobath will talk about the financials, and Chris Fedde will talk about Hexis. In the Q&A, Chris Donaghey will also be available.

There’s two overarching things for today’s call. One is the federal government budget process during 2013 or as our Senator Mikulski says, the era of shutdowns, slowdowns and slam down politics. That clearly had an impact on the fourth quarter and we expect it to continue in the first quarter. The end of sequestration does mean our customers can now allocate funds to the critical programs we support. We know that Cyber and C4ISR are going to see increases in 2014 and 2015, but the money has not yet begun to flow.

Thus, revenue is likely to be slower coming in than we would like and therefore perhaps we’ll be even further down in the first quarter. However, the good news is that the 2014 funds must be spent in the remaining part of the year. So your guess is as good as mine as when money will flow. Folks say it flows at the end of February, March then a lot of money has to be spent in seven months. So we believe it will pick up and be a robust year for us in the government side. The question is when does it start? While I wish that the 2013 results were better, I believe that we have fared better than many in our government sector because of our relationships and because of the kind of work that comes to us.

One indication of growth for the future is the number of vacancies we seek to fill. If you look back a year or so, we were trying to fill 300 vacancies. When sequestration hit, it came down to about 100 vacancies. Now we’re up to about 160 vacancies. So we’re beginning to see the growth already. However, as people have to be hired, money has to flow on contracts and we have to (inaudible). We have existing vehicles to put the money on. So that is a distinct advantage for us as they look to spend money.

As the press release says, we also have won several major prime contracts. John will discuss that in a few minutes. The second major overarching thing is Hexis. That’s our commercial Cyber Solution subsidiary that's effective as of 1 January and a wholly-owned subsidiary by us. Chris will say more about the progress, but I’m pleased with the progress. We’ve doubled the sales force. We have a substantial pipeline and HawkEye G is doing what it’s supposed to do. It’s finding bad things, fixing them and removing them. In one case, we found a very advanced persistent threat in less than one second and we moved it in 33 seconds. A remarkable achievement is doing what it’s supposed to do.

In order to achieve those results, we’ve had to increase our investment. The cost of the sales team and the marketing we’re doing in addition to those in development, certainly have increased our costs. So that has affected EBITDA. Fourth quarterly we had very strong Government Service to EBITDA, 16.8. I think that’s currently above average. 16.8%. With the impact of Hexis that resulted in overall EBITDA of 10.2%. For the full year 17% and for the Government Services but with the impact of Hexis it’s 9%. I’m very proud that we made a great deal of progress in a much shorter time than many companies have in Hexis and we’re still returning a reasonable overall EBITDA instead of losing $100 million in hyping our products.

One other point before I ask John to discuss the financials. It’s well known that we don’t give guidance. I’d like to give you my view of the first quarter in 2014 because I know that’s important, but simply too early to do so. We don’t know when the government funding will make it on contract. Many of us here in the east are suffering with snow storms, and we listen to weather guessers talk about how much snow we’re going to get when, and it depends on the wind. It depends on when the cold front comes through. So we feel like that in the government contracting world. There’s too many ifs, or ands, and buts to be able to predict when the money will flow.

We’re very excited about Hexis and HawkEye G in particular and really believe we’re going to have a healthy year in bookings and sales, which should fall within the range that most analysts have predicted of $20 million to $40 million. I’d like to be able to tell you more about that, but it is just February. So our plan is to get more visibility on the government side and on Hexis in our second Analyst weekend in March. Our goal is to give you better idea of what’s going on because we’ll have better information at that time. John?

John Krobath

Thanks Len. Q4 was fairly busy for us. We started with the government shutdown and as we talked about on the previous call, that cost us about $3 million in revenue predominantly in the government side on the services. We hope to be able to make up some of that during Q4. Unfortunately with the holidays and the contract deals we were working in most cases, that was not an option.

So as we work through that, as we previously reported, we got an Air Collection Services contract for $115 million in December of which $54 million is funded through March of 2015. That was competitively bid. It’s a change in our contract from what we’ve seen previously in the Air Services. The structure is different. The base profitability is less than what we’ve had in the past. But there are a number of add-ons and options, some of which have already been exercised that will enable us to get a better idea of how the contract moves forward.

We also had the commercial release of HawkEye G in October and probably the biggest change in terms of modeling and financials is the change in our reportable segments. Previously, we’d had the services segment and integrated solutions. Given the larger profile of Hexis and our Commercial Cyber Solutions, what we’ve done is we’ve segregated our segments to Government Solutions and Commercial Cyber Solutions effective in the fourth quarter.

The reason is again the growing impact of our Commercial Cyber Operations, the fact that our Flight Services and Products have become much more integrated into our service offerings on the government side. It just made sense at this point to go ahead and make that change in our segment reporting. In terms of the history, the Commercial Cyber work goes back to Q4 of 2012 with the acquisition of Sensage. Prior to that, everything is government solutions work. So as we go through, you’ll see as the numbers come out, the comparisons to prior year in terms of where we were.

For Q4 we did $69 million. As Len touched on, EBITDA was $7 million and we had a loss of $500,000 or $0.01 a share. In terms of detail on the government side, we did roughly $65 million in revenue with a gross margin of 35%. EBITDA as Len said was 16%. There’s two overriding factors in that number. We had about $3 million of one-time hardware sales in Q4 that had a very significant EBITDA and gross margin contribution for us. As Len said 16% is not our normal. You’re looking more in the 12% to 13% range as we go out. On the commercial side, we did $3.4 million in revenue, just over an 80% gross margin.

The operating expense there was $6.9 million in the quarter. That’s an increase from the $5.5 million we had in Q3, which again is an increase from $3.8 million in Q2. A lot of that has to do with the infrastructure, the sales team that’s been put together and Chris Fedde is going to talk about that more in terms of numbers and who we’re adding and how when he talks. The EBITDA was actually a negative EBITDA of $4 million within the commercial group for Q4.

Related to the balance sheet, we’ve always had a strong balance sheet. It’s getting better. We’ve invested in some inventory as it came towards the end of the year. This year we do not have a reserve on our inventory any more. The products are a more mature product line. We know where things are, so there is no reserve this year.

Cash flow for Q4 was zero. However, we had about $9 million in Q4 specific payouts that are not our normal monthly flow or quarterly flow for paid time off, payouts at the end of the year, employee bonuses and legal costs. As we look out towards 2014, as Len said, we’re not going to talk about the topline, but we’re looking on the Government Solution side of 30% to 31% gross margin. As you guys know, when we talk about the products that underlie are part of that depending on the maturity of those products. That impacts the overall profitability there. Regarding EBITDA, again we’re looking somewhere in the neighborhood of 12% to 13% on the Government Solution side.

On the Commercial side, again we’re looking for a low 80s gross margin. That will include the amortization of the capitalized software cost of about $4.5 million related to the development of HawkEye G that we stopped capitalizing back in June of this year. The OpEx, while we’ve been growing significantly 40%, 30% over the last two quarters, the growth will not be as significant while we’re still adding sales folks. A lot of what we have is in place. Hopefully that number will grow as we put the commission line in there, but in terms of the base cost and the infrastructure cost, a lot of that has been incurred. We’ll still grow, just not at the same rate.

When we look at the intangible expense, while we were just over $24 million, $24.7 million for 2013, right now the intangible expense, excluding the amortized capitalized software for G is going to be about $11.7 million for 2014. So that’s one significant change. Probably the biggest change there is the fact that all of the intangibles related to the Flight Landata acquisition of about two and a half years ago, their amortization ended at the end of 2013. Chris?

Chris Fedde

Thank you, John. On the last quarterly call, we said that we are happy with the Hexis organization as far as the product line management, the product marketing, customer support, the delivery. We had rock solid people in those positions and we were pleased with where we had built the organization. However, we said we had more work to do on the sales build up.

Since the last call we have transitioned sales. So let me start there as far as what we’ve managed to accomplish. First thing we did was we moved Pat Reilly in to head up all of our sales department. Now, Pat came to us in late November. He lives in Silicon Valley and has built, serially built successful sales organizations from there. And in January we named him the head of all our sales organization. The first thing he did was bring in Dick Schaeffer to head all of our Americas sales organization. Dick, you may recognize his name, most recently built out the Sophos organization in Americas. So both of these are obviously experienced folks, experienced building sales organizations, but more importantly they’re both experts at the channel go-to-market model. They are experts at the all-channel model. And so that’s enabled us to make a transition to an all-channel sales organization.

So don’t get me wrong. We’re still in enterprise sale. We’re still going to have direct touch to the customer. We are still going to be putting senior sales people in there that deal directly with the customer. But we have made the change now to the channel partner model throughout our sales organization. And in turn, we’ve been adding people to sales that are used to that model, people that know which partners they want in their regions and can immediately start bringing those sales channel partners on board directly.

So if you look across the folks we’ve added into the sales department, you can see a reflection of this model. You’re going to see we’ve brought on people from Mandiant, Cisco, Sophos, Websense, Symantec, Dell. These are experienced people, people that know how to manage both the direct customer touch as well as the channel model and that’s what we have staffed our sales organization with them.

As far as the size, we also said in the last call we needed to increase the size. We have hired 10 sales folks since we last talked. We had done some reductions in parallel with that. We did move a few folks out of the sales organization that didn’t fit the new model. So the ones we have are rock solid. The folks that have been with us for a while are those that are very good at this model and as I say, we’ve added people that are very good at this model and building this model and bringing on the right partner. So I would report to you we have made the transition. Last partner announcement we made was a company called PGI, a UK company. We’ve got a lot of activity with them right now and what we’ll be able to report in future calls are the additional partners that we’re bringing on in a similar manner as PGI was.

So we’re still hiring, we still have in our budget slots for 10 more people. We are planning to bring on 10 more people during the course of the first half. So this isn’t urgent. We’re going to continue to be very selective on who we bring on in this regard, but we are going bring on 10 more sales people mostly for the U.S. We had our sales kick off last week. We got everybody together and you could tell this team was gelling very well. These are people that are like minded. They’re here because they’re experienced and they’re excited about what we had to sell in Hexis. And it was just an excellent sales kick off that took place all of last week. So in total, in Hexis we now have about 115 people. 13 of those are contractors on the product development side. As you know both coasts, at our San Mateo office as well as our East Coast office in Hanover, have a large pool of contract engineering that prefer to stay contract engineering and that’s fine. We will continue to supplement our own folks with that. But we have over 100 Hexis employees and then about 13 contractors.

So as you can tell, in addition to increasing our sales force, we have added to the product development and we have added to our product marketing too by the way. Just this week we added a product marketer for channels. Where did she come from? She came from Barracuda, so you can see where we’re going. We are going to -- we’re going to go right down that channel vein and we are going to make that successful. This is -- Hexis is not a platform for on the job training. These are experienced people that we’re talking about that they’re going to come in and they’re excited about making this a successful organization.

Let’s talk about the pipeline. As you know we had four betas. Two of those betas have been converted to customers. One is committed and the PO is in process, and I predict that we’ll get the fourth one still during the fourth quarter -- first quarter, I’m sorry, still get the fourth beta during the first quarter. So we will have them all converted. We’ve got 20 active HawkEye G engagements right now. I’ll define active engagements. These are 20 customers that fit our target market. These are people that understand the advanced threat, understand the liability they have in the advanced threat. They have high value information to protect. They have money to spend and we’ve had multiple interactions with them and so we have 20 of those going on.

The range of deals is on the low end $150,000. On the high end it’s over a million and a half and it’s a very healthy mix. I’m real pleased with the mix. We’ve got potential customers from finance, in energy, health, medical, tech companies. We’ve got three internationally. These are EMEA customers. So it’s a very healthy mix of active engagements right now. One thing we did learn from recent experience here, our experienced sales folks have said this and our larger customers are telling us the same thing and that is our larger customers would like us to give them the option of pricing a product as a multi-year term based license versus our standard perpetual license with a subscription.

They’ve got their own reasons for that. Some of them it’s CapEx versus OpEx. Some of them just want to get a flatter expense profile. Whatever it is, we’re glad they’re asking. The answer is going to be yes. We will fashion that for those larger customers that they want to. But we don’t know what that mix is going to be between the two. So what we have done is changed our quotas on our sales people to a bookings quota. And again, this is all goodness. We’re doing this because we want to say yes to our customers and get them on board. But I don’t know what the mix of perpetual license versus term license is going to be. So we’re going to measure our sales folks on bookings.

So in closing here, I’ll just say we were pleased with the results so far as Len said. Our new pilots are going smoothly. We’ve got pilots underway right now. They’re going well. Actually our first customer -- this is particularly interesting. Our first customer for G that was not a beta customer bought the product without a pilot. In other words came in, got a technical briefing, understood what he was getting and bought it without a pilot. So there’s just lots of good indicators there. As Len said, HawkEye G is doing what it’s supposed to. It’s finding and removing the advanced threat before it can compromise the networks.

And as another measure of success, remember our beta customers chose our products, chose to be beta customers of our products because they had been victims of the advanced threat. Since last May when we started our beta program, there has been no beta customer that’s been attacked -- successfully attacked. G stopped all the attacks. So no matter how you look at it, we’re very pleased with the results going back to our beta program and of course since our beta customers are now two customers, it’s just been continued success, continued evidence that the product is doing exactly what it needs to do for these customers. So that’s the report from Hexis.

Leonard Moodispaw

Thank you, Chris. One more point. While we cannot disclose many of our customers and companies with which we work, there’s one relationship I do want to highlight and that’s our relationship with Oracle. We’ve been working closely with them on combining our technologies to deliver Hexis’s solutions to their broad enterprise based customer base, which includes good commercial and federal markets. Their technology holds great promise for us to rapidly cloud any who are customers so that we can focus the bulk of our efforts on meeting the unique mission needs. We started out with a relationship with their national security group and expect to broaden as we go forward. So that’s a very promising relationship.

With that, I thank you and we will take questions. Once again, Chris Donaghey is here to help with questions as well as Chris Fedde, John and I. So please folks, fire away.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Brian Kinstlinger of Sidoti & Company. Your line is now open.

Brian Kinstlinger – Sidoti & Company

The first question I had -- Chris, thank you for the details. I'm interested, were any customers added or accepted to take on HawkEye G? I was confused a little bit about pipeline. Have you have added any thus far in 2014? And then try to help us evaluate as we try to look through the year at the progress, when is that quarter where you think the Company and investors will say, aha, I see lots of other customers are taking it. They see the benefits and it will be a quarter where you'll see 10 or 15 customer wins.

Chris Fedde

That’s the money question, right? As these things --

Brian Kinstlinger – Sidoti & Company

Right. Like the first one.

Chris Fedde

As these things converge, you’re going to get critical mass and it’s going to take off. And we were saying all along that our goal is absolutely to make that happen in the first quarter. I told you last time and I’ll say again, that depends on us getting the sales activity really gelled quickly. I’m pleased with the way that’s come together. So I would still say that we hope to see that inflection point happen in the first quarter so that the second quarter we’re reporting just what you said, a percentage of active engagements turning to real customers. So where is it in that first quarter, beginning of the second quarter? I don’t know, but that’s certainly where we are all focused on timing wise is making that happen in that time period. Yeah, there is a customer and checked this morning to see a couple other in the works here. But there are customers besides our beta customers if that was part of your question. The 20 active engagements that I talked about are the sales folks we do have. These are the customers we are pursuing right now.

Brian Kinstlinger – Sidoti & Company

So you did add customers. You added one more or you added two more? I'm sorry to be so precise, but can you give a number that you've added?

Chris Donaghey

Yeah. Hey Brian. So the explicit number we have signed a customer that has bought the system that is outside of the beta program. And we have installed a pilot in another customer that is not -- and those are mutually exclusive of each other. And I believe we’ll be shipping out another pilot. If it didn’t ship today, it should be very soon as well. So we are now starting to expand the number of systems beyond the beta customers as we speak.

Brian Kinstlinger – Sidoti & Company

That's great to hear. Now the 20 in the pipeline, is that a pipeline Chris you think about that is sold in the next one or two quarters, because you're talking about a big pickup in sales in the second quarter or first quarter in signings. Is that pipeline a short-term number and you’ve constantly got to build that for the second half of the year?

Chris Fedde

It is a mix. I would say it’s a mix of first half customers, first half potential customers. The other thing I’d keep in mind is these are the ones that we engaged with -- we found and engaged with back when we had direct sale as our model. And so we’re following through there. What you’re going to see turn out though is our partners bringing us customers. So if you’ve got -- if our typical regional sales person brings in let’s say three channels that are known to him and those channels start bringing in the customer that they’re familiar with, that’s when you’re going to see that force multiplier. That’s what you’re going to see from here on out. So those first 20 were done I would say kind of under the direct sale model, but from here on out, you’re going to see the effects of the channels. But I think all 20 active engagements now have the potential of being first-half orders.

Brian Kinstlinger – Sidoti & Company

Okay. One more, and then I'll get back in the queue. I got a lot. Flight Landata, you mentioned the terms of agreement are less profitable. Can you give us a ballpark of what that means in terms of less profitability? And then I think investors all want to know about the predictability of the flights out there given what's going on in Afghanistan. So maybe give us an update on your thoughts there.

John Krobath

I’ll take the first half of the question, Brian. On the profitability, it’s down slightly. What’s getting us is the add-ons. We had an add-on command right at the end of December. That was not part of the base contract. The way the structure of the old contract was there were a lot of things that were included that we did under the base cost of the contract. When the bid came out, a lot of those what I’ll call free services under the original contractor now priced down as options. As those options get released, we get more profitable. So in order to give you a real number of where we’re going to be, it’s not going to be a significant drop in where we are in terms of profitability, but it will be less on the revenue side in terms of what we’re getting because a lot of the cost is -- are baked into our model of how we operate and the various locations that we are.

So I’m not ducking your question. We just don’t know because they were talking about another option the other day in terms of what we might do. As those come in that affects it. And some of those options are an option to do additional services. Some of the other options are, were we to go to a new location that the cost there would be cost reimbursable. If we get into something like that obviously the profit margin is different because now we've got revenue and cost being the same thing. So it’s still playing out. We’re going to know more as we move forward under the contract and I’m going to let Chris talk about the second part of your question.

Chris Donaghey

So the second part of the question, can you just restate it again for me, Brian?

Brian Kinstlinger – Sidoti & Company

Yeah, sure. I think, if I recall, you have six planes? Am I right? And obviously, we’re pulling back in Afghanistan. And I think investors, certainly one of the biggest questions is, what's the predictability certainly of that contract? What's the predictability of flights there and demand, and could that -- could the number of flights begin to drop off?

Chris Donaghey

Right .So again I would refer back to the press release that we put our in December. So right now, we are funded for all six aircraft through March of 2015. And whether those aircraft are flying in Afghanistan or some other part of the world is largely not material. We do anticipate that in 2014, aircraft are going to start to move around. When and where, we don’t have all of the specifics on that, but we do know that the customer intends to use those six aircraft through the funded period.

Operator

Our next question comes from Stephen Cahall of Royal Bank of Canada. Your line is now open.

Steven Cahall – RBC Capital Markets

Good evening. Thanks for all the color this evening.

Leonard Moodispaw

Thank you, Steven. Are you still in London?

Steven Cahall – RBC Capital Markets

I am, yes. That's all right. It's always Margaritaville here.

Leonard Moodispaw

Oh, five o’clock somewhere. Okay.

Steven Cahall – RBC Capital Markets

Maybe the first one, I just have a couple questions. The first just for Chris on what you discussed of the multi-year agreement versus the perpetual license. Can you just maybe give a little bit of a feel for how that affects the revenue profile of a customer? Does it change the upfront revenue? You talked about it becoming a bit more flat, perhaps, over the life of a contract. So, maybe you can just describe that for us, that’d be helpful.

Chris Fedde

For them the expenses are flat. For us it affects the recognition of it because when it’s a perpetual license where we recognize the perpetual license up front and then the subscription is ratable, straightforward. We expect that to be most of the customers. But if the larger ones want to take a multi-year term license, that affects the way we recognize it. We wouldn’t be able to recognize it all upfront. It’d be recognized over the term of the agreement. Is that okay?

Steven Cahall – RBC Capital Markets

Yeah, that does. And then also just on the sales force, you mentioned that you were up 10 in the quarter. You also had some changes there. What's the -- maybe I missed it, but what's the net number of maybe sales and sales engineers folks that they have now at Hexis?

Chris Fedde

I rounded off plus or minus one. It’s 20 quoted carriers. That includes the sales folks and their SEs. They’re both quoted. We’re maintaining a 2:1 ratio of sales to SEs and we expect to bring on 10 more sales folks and then their equivalent number of SEs during the first half of the year.

Steven Cahall – RBC Capital Markets

Okay. And then maybe just a last one for John, and then I'll get back in the queue. The CapEx and including the R&D, that was down in the quarter. I think you talked about that the R&D was essentially done. But is the run rate that we see there of expenses of the CapEx and R&D a pretty good run rate to project forward, or was there something that made it unusually low in Q4, and it may step up again for an average for the next year, for 2014?

John Krobath

I think CapEx was, we were very high in the first part of the year. We came down. Q4 was probably a little lower than what we’ll see going forward. We were doing some build outs early in the year. Most of those came to a close. We’ve got one build out we’re working on with regard to the Flight Landata operations up in Boston that will come on in Q1. So CapEx was probably a little low than what you’d see going forward.

Operator

Our next question comes from Mark Jordan of Noble Financial. Your line is now open.

Mark Jordan – Noble Financial Group

Good afternoon, gentlemen. I'd like to talk a little bit about the legacy Sensage SIM business. I would assume that the vast preponderance of the $3.3 million was out of the legacy SIM business. I do know that you announced a next-generation SIM in the HawkEye AP I think late in the year. Could you talk about how the AP is different from legacy, from the prior product? And secondly, did that relatively late announcement have a negative impact on SIM sales in the fourth quarter?

Chris Fedde

Yes. There are a couple of elements to this and John will be able to answer further, too. The legacy Sensage product was marketed as -- and I’m talking prior to being in KEYW. It was marketed as a SIM. It was not very successful. And the new license business was continuously eroded because of that and by the way, continued to erode because, like I said the SIM market was one that fundamentally had come and gone and it wasn’t really well positioned there. What we did do, to answer your question is we’ve added -- we’ve brought it up to date as far as the data warehouse. We had to do some things to improve their performance and we added better analytics to it so that the users can add their own analytics or third parties can add their own analytics.

That’s being done now and that will continue to be done for some months. But continually gets better from an analytics standpoint. So they can be used in a fairly broad range of uses, security as well as non-security. So we have seen an uptick in new license over the last few months. So we are seeing that we did turn the trend around. That’s good. But it’ll take some time to rebuild up the deferred revenue services that goes with it. Yeah, so I didn’t cannibalize any of the old Sensage business. The old Sensage business like I say was kind of going the wrong direction anyway. So this was all about turning that around.

Mark Jordan – Noble Financial Group

Okay. Talk a little bit about cash needs. Obviously, your traditional Governmental Services business tends to be cash flow positive, but is there going to be any -- what are the incremental needs of the Hexis Group as it hopefully grows quickly through the year?

Chris Fedde

Actions?

John Krobath

We’re pointing at each other, Mark, to see who answers the questions. So I’ll take this one and I’ll take a quick shot at it which is as we grow the sales force. So there’ll be expenses of the sales force before they generate sales. So there’ll be a period of just like we had in the fourth quarter of increased sales with that impact on the EBITDA. I don’t know that it's actually in the plans leading to a cash need.

Chris Donaghey

I think the cash we generate under the government side of the business Mark is enough to cover whatever cash needs we have on the commercial side.

Mark Jordan – Noble Financial Group

Okay. So you would expect, as you saw in 2013, at least a modest decline in overall debt that you shouldn't have incremental cash needs here to ramp this business? That shouldn't be a constraining factor?

Chris Donaghey

That’s correct.

Mark Jordan – Noble Financial Group

Okay. Last question for me. The beta process, as you mentioned started in the May-June timeframe and really extended late into the year. Being a relatively long period of time, how much was HawkEye enhanced during that period? Why was that beta period as seemingly as long as it was?

Chris Fedde

The reason for it being lengthy was primarily because it was a first-of-kind product. There are no other products out there active removal capability. And when you’ve got a first-of-kind enterprise scale product, it really does take that long to shake it out, make sure that it does what it was intended to do and to get it ready for prime time. So we expected it to be six months and it was six months. By the way, six months is also the amount of time we believe it takes to find the very, very stealthy threats. So we actually would have wanted to run it six months anyway. But I would say fundamentally it was because it’s a first-of-kind product and before we go dropping it in people’s enterprise networks, we really wanted it to have confidence in it.

Chris Donaghey

Mark, this is Chris. I would just clarify that as we talk about pilots going forward, these are not six month engagements. We believe the product is at a level of maturity now where if we give you a pilot and those are all negotiated on a customer basis, but if we give you a pilot it’s essentially a 30 day trial period. At the end of that 30 days, you’re either going to write us a check and buy the product or we’re going to take it back. So the pilot phases are not intended to carry on indefinitely. There are defined periods of time and at the end of that period of time you either buy the product or you take it back.

Operator

Our next question comes from Tobey Sommer of SunTrust. Your line is now open.

Tobey Sommer – SunTrust Robinson Humphrey

Thank you. Many of my questions have been answered, but I’ve got a few more. Len, in your prepared remarks, you described I guess an incident where G spotted some malware and then removed it relatively quickly. Was this an organic piece of malware, or was this a test or something that one of the G Team infiltrated the network?

Leonard E. Moodispaw

I’m going to ask Chris Fedde to answer the question, but I’m going quiver with your relatively quickly because it’s extremely quick. Nobody else can get it done anywhere near that. But Chris you want to comment on that particular incident?

Chris Fedde

Yes. I'll start by emphasizing we do not implant infections in our customers.

Leonard E. Moodispaw

That’s right.

Chris Fedde

This was a real life Zeus variant that got past the perimeter protection as targeted threats are known to do and was removed in in -- As Len said, the total time removal was about 34 seconds, clearly before it had time to do any damage to the network.

Tobey Sommer – SunTrust Robinson Humphrey

Perfect. Thank you. And I like your usage of extremely, Len. I wanted to ask you to characterize the 20 or so active engagements. How many of them are existing -- formerly Sensage and now HawkEye AP customers versus maybe what could be considered a little bit more greenfield with the new product in G?

Chris Fedde

Hold on. Four of those are AP customers, or Sensage customers.

Tobey Sommer – SunTrust Robinson Humphrey

Okay. Perfect. And what size should we think of the new incremental HawkEye G customer, as well as what I guess will be two incremental pilot customers at least as of the end of this week?

Chris Fedde

The size in terms of dollars?

Tobey Sommer – SunTrust Robinson Humphrey

Potential sale, yes.

Chris Fedde

Well, we're really not pursuing orders that would be or opportunities that would be smaller than $150,000. We’re just not. There’s probably no end to how big we'd pursue, but I would think that the upper end is about $1.5 million, between $1.5 million and $2 million. That’s for a very large organization.

Leonard E. Moodispaw

And that’s essentially $1.5 million to start in a big organization and as they see that it works in a particular division then they’ll grow and grow and grow from there.

Chris Fedde

And that’s net to us. We have built into that our channel margins. So that’s what the company will see.

Tobey Sommer – SunTrust Robinson Humphrey

Okay. Thank you. That's helpful. And then, Len, I wanted to ask you, is the relationship that you highlighted with Oracle in any way an exclusive relationship that confines future partnerships?

Leonard E. Moodispaw

No, neither side.

Tobey Sommer – SunTrust Robinson Humphrey

Okay. And my last question, I'll get back in the queue. Just a little clarification because I didn't quite catch all of your prepared remarks in which -- Len, did you say that the first quarter Services side -- or Services revenue is likely to be down a little bit sequentially?

Leonard E. Moodispaw

I said -- we didn’t say likely. Maybe. We just don’t know. So if I’m predicting I have to say it’s probably down a little bit, but it’s conceivable that things could explode and we can go up. I just don’t know.

John Krobath

Tobey, this is John. One note on that is we did have $3 million of hardware sales in Q4. That order, specific one-off orders that we don’t have any visibility to in Q1. So we’ve got that to work on just to get back to whole.

Tobey Sommer – SunTrust Robinson Humphrey

Okay. So we’ve got a tangible discrete item to consider?

John Krobath

Yes.

Operator

Our next question comes from Jim McIlree of Chardan. Your line is now open.

James McIlree – Chardan Capital Markets

John, what was the commercial OpEx in 2013 in dollars?

John Krobath

The commercial OpEx was $19.4 million.

James McIlree – Chardan Capital Markets

Okay. And you said that that’s going to grow in 2014, but at a rate less than the 40% to 50%. Is that right? And that pace is going to be driven by the success of the pilot programs et cetera. Is that a reasonable way to look at it?

John Krobath

I think that’s a reasonable way to look at it. As Chris said, they’re still going to add another 10 to 15 folks on the sales side during the first half of the year. So you’ve got that added cost. A lot of the infrastructure cost is already baked in. When you look at what we ran, we were $3.1 million in Q1, $3.8 million in Q2. We jumped to $5.5 million in Q3, but at that point we’d stopped capitalizing the software because it was in a state that could be in the beta networks. And then we came up to $6.9 million in Q4. So we’re going to see the growth, not the exponential growth in that expense that we saw, but the one variable is as the orders come in and we start to pay the commissions, that’s going to come through that OpEx line as well. So we hope from that perspective it grows quickly.

James McIlree – Chardan Capital Markets

And how many channel partners do you have now and how are they organized? Is that organized by verticals, by geography, by a little bit of both?

Chris Fedde

Geo, geographies. We have some legacy partners particularly in the EMEA. I think there’s a few in the U.S, several in EMEA. We’re still scrubbing in to see which of those we’re going to stick with. But from here on out, it’s going to be geographically based. So the sales folks that we’ve hired that we were taking about all came with knowledge of who is strong in their regions, particularly for these kinds of security products. And so we expect that to convert to named channels with in turn their named potential customers fairly quickly.

James McIlree – Chardan Capital Markets

And how many channel partners do you have now?

Chris Fedde

The number is probably 12, but I think that’s misleading on the high side. Not all of those channel partners that are going to survive our wire brush here when we decide who’s up to speed. It’s really going to be the new ones that we have the greatest opportunity with.

James McIlree – Chardan Capital Markets

So tell me if I understand this timeline correctly. So right now you have these 20 engagements, and those were driven by the old, let's call it direct sales force.

Chris Fedde

Yes.

James McIlree – Chardan Capital Markets

Right now, you're engaging with the new channel partners?

Chris Fedde

Yes

James McIlree – Chardan Capital Markets

And will take them -- so it will flush out these 20 engagements, and then the plan is, at that time, that the new channel partners will have brought in the new pilots, and you'll start ramping from there. Is that -- again, is that a reasonable way to think of it?

Chris Fedde

Yeah. The other thing I’d add is some of the ones we do have did come through channels and all 20 are being converted to a channel, are being handed to a channel. So they will all come back in under – under partnership with one of our channel -- designated channels. So yeah. The 20 we have now we’re manually fleshed out and those will get turned over to the channels as well as the channels starting to add their own during the next quarter.

Chris Donaghey

Yeah. And Jim, this is Chris. Sales is not really a serial process. You’re going to have our direct sales team are going to be directly engaging with customers that they have relationships with, as well as building relationships with three to five channel partners in their region as well and they can do all of that concurrently. They can manage this process even with more than one or two at a time. So we expect all of this to be going as the sales force ramps up.

James McIlree – Chardan Capital Markets

I appreciate that. Thank you. I guess what I'm really asking both Chrises is, is there a discontinuity as you change from that direct to the channel? Even if it’s a small one, is there some burp in the pipeline or burp in the sales because of that change? –

Chris Fedde

No. I think it all has an accelerating effect. If we hadn’t converted to a channel, we would be adding sales folk -- we would be adding potential customers as fast as we could add sales folks. Now that gets multiplied to the channels. So I would just -- it takes the whole process and moves it up. So once all of the traction is gathered, this should take off much faster.

James McIlree – Chardan Capital Markets

Okay, great. Thanks a lot, and good luck.

Leonard Moodispaw

Jim, one other point. This is Len. We haven’t talked at all about the potential government sales. We now have governmental customers beginning conversations with us. So that’s a whole different angle. Second point is I’m coming your way so clear out snow, will you?

James McIlree – Chardan Capital Markets

I’ll get my shovel out right now, Len.

Operator

Our next question comes from Josh Sullivan of Sterne, Agee. Your line is now opened.

Josh Sullivan – Sterne, Agee & Leach

You may have answered this, but did the fourth-quarter Commercial sales include revenues from the betas turning over?

Chris Fedde

No. Everything in there is on the beta turnover.

Josh Sullivan – Sterne, Agee & Leach

And then if we look at the $20 million to $40 million of Commercial sales, what does the cadence look like in the first half versus second half? I know you're looking for the inflection point, but what's your sense right now?

John Krobath

The 20 to 40?

Chris Donaghey

So my expectation is that from a revenue ramp perspective, it’s clearly going to be more back end loaded. That’s just kind of the nature of where we are. The sales force is mostly new. So the first quarter would definitely be the lighter of the four quarters. In the second quarter you start to see some of those deals start to convert and by the third quarter you’re starting to see it happen at a very rapid pace. So you should see pretty strong sequential growth from a revenue perspective over the course of the year.

Chris Fedde

And we had the disadvantage too that -- in the commercial business fourth quarter sequentially the first is typically down anyway. That’s just the nature of the commercial business. So we have that as a headwind going into the first quarter.

Josh Sullivan – Sterne, Agee & Leach

And then just from a higher level, in the security industry, do you see any evidence of like a firewall, a refresh cycle you can get in front of (inaudible) or what's your sense of corporate security budgets in 2014 and maybe into 2015?

Chris Fedde

What I think we’re seeing is a willingness to spend money on the advanced threat. I think the real tectonic shift has been people acknowledging with funding that the threat gets past the perimeter, and so we’re not necessarily competing with perimeter dollars any more. In other words, we help people to do what they can to -- you should put -- whether it's FireEye's or Sourcefire's or Palo Alto's, put what you can at the perimeter. This is a different topic. This is how do you get the advanced threat that sneaks past that? How do you get that removed? I think what we’re seeing there, people acknowledging that that is in fact necessary and they're acknowledging it with their budgets.

Operator

Our next question comes from Patrick McCarthy of FBR Capital Markets. Your line is now opened.

Patrick McCarthy – FBR Capital Markets

Hello, guys. Good afternoon. Thank you very much for taking my call. I was wondering if you could double back to the defense side for a second and talk a little bit about the pool programs for the year. Obviously, relatively weak compared to the expectations heading into the year. Maybe just a debrief on what happened in 2013. Maybe and an update on the program status moving forward and just a general feel for 2014 on that one.

Leonard Moodispaw

The problem, as I suspect you know with sequestration was the customers were subject to that slam down that Senator Mikulski talked about. They had no choice about where to cut money. It was cut program by program, sometimes as much as 20%. So that radiant program was subject to that, just like any other programs. So the major cause for that being lower than we like was sequestration. The good news about it is it a wide open vehicle with a customer we’ve been working with for lots of years on very crucial programs so that as money begins to flow again we expect it to grow back to where we had hoped it to be. The biggest problem, sequestration and the furlough.

Patrick McCarthy – FBR Capital Markets

And can you tell us, of the additional bodies that you have from a vacancy perspective, that increases of 60, how many would be attributable to the pool program?

Chris Donaghey

Hey Patrick. I don’t think we can provide that level of detail. I don’t think we mention program names in the individual job openings, but the one thing that you could see if you were to go through the majority of the openings you would definitely see government versus commercial and a significant number of the new open positions are government positions. And some of that is related to new bid and proposal activity, which is good to see. And some of that is related to existing programs that are starting to have confidence that the funding is on the way. So they’re willing to open new positions for evaluation.

Patrick McCarthy – FBR Capital Markets

Okay, great. And then just on the Commercial opportunity, I'm just wondering as you've dealt with these betas and you put the system on people's networks, have you learned anything about the installation? Has it been as smooth as you were hoping? Have there been challenges? Just maybe some feel for what you're thinking about as you start delivering hopefully more of these.

Chris Fedde

That was absolutely part of the learning process in the betas was how do we -- the first beta was -- took days and the fourth beta took an afternoon. So we are fast learners if nothing else. The pilots that we're putting in -- we put in a pilot that Chris referred to. This is one of the larger ones. This is going into a really large organization and it was put in in a day.

Operator

Our next question comes from Jeff Osher of Harvest Capital. Your line is now opened.

Jeff Osher – Harvest Capital

Within the quota-carrying sales force, who is running the division right now, specifically the Commercial division, and is in charge of the geographic dispersion of that sales force?

Chris Fedde

The head of sales is Pat Reilly who lives in Silicon Valley. He’s the one I referred to as the one that has done this successfully serially. He’s a known quantity to us. He was exactly who we wanted to run this. Actually he runs everything in North America which of course will be the bulk of the bookings for the first year anyway is being run by Dick Faulkner. He’s the one that built out the Sophos --

Jeff Osher – Harvest Capital

What happened -- we brought in, I believe his name is Dan Kuczkowski, from Oracle. You guys' press release said nine months to head of all of Commercial sales. What's his role right now?

Chris Fedde

Dan decided to move on to another opportunity.

Jeff Osher – Harvest Capital

Wait. He was brought in to run Commercial sales nine months ago. Correct?

Leonard Moodispaw

That’s correct.

Jeff Osher – Harvest Capital

Can you elaborate on why he left ahead of our big ramp?

Chris Fedde

Let’s just say he was here before I was.

Leonard Moodispaw

We’re dancing because we don’t like to talk about personnel matters. So we’ll just say we’re very happy with Pat Reilly and with Dick Faulkner.

Jeff Osher – Harvest Capital

Okay. Hey Len, how do we think about the $75-million Commercial target by 2015 given the backend-loaded nature I guess of the 2014 ramp? And if there's a six-month window for a refresh of engagements from the indirect channel, and we assume an ASP, call it in the middle of the $150,000 to $1.5 million range. Should we be dialing that $75-million target back for 2015, or do you still feel pretty good about that given some of the push-outs?

Leonard Moodispaw

I am the guy who has a sign on his desk that says instant completion isn't fast enough. So I’m still sticking with $75 million.

Jeff Osher – Harvest Capital

Okay. Last one for me. Within EBITDA, are you guys adding back the amortization of capitalized software?

John Krobath

We haven’t because we haven’t amortized any of the capitalized software to date. So, through 2013 that is not in there. As we move into 2014 it would be EBITDA add back because it is it is amortization as a non-cash expense.

Jeff Osher – Harvest Capital

Right. But then your expense for Hexis development never closed through the EBITDA line. In other words, we never see the expense for the development.

John Krobath

Correct. As we capitalize the $4.5 million to start with and the cash came out there. So it didn’t come in there. It’s somewhat of a fixed asset in which case you’re going to see the deprecation not come through the same line either.

Jeff Osher – Harvest Capital

Depreciation or amortization?

John Krobath

If you go through the same logic on fixed assets, when you depreciate it, it doesn’t come through the income statement --

Jeff Osher – Harvest Capital

No, I understand the add back, but typically it's for PP&E, not capitalized software. But also, just a heads up, your cash flow statement, add back doesn't reconcile with your D&A in the EBITDA table. So any -- perhaps it's a rounding error? Maybe -- let's follow-up off-line. Thank you, guys very much for taking my questions.

Operator

Our next question is a follow up from Brian Kinstlinger of Sidoti & Company. Your line is now opened.

Brian Kinstlinger - Sidoti & Company

Thanks. The $3 million lost from the government shutdown on Services, I think you said, in the fourth quarter, is that revenue not bouncing fully back in the first quarter?

John Krobath

That revenue is from the point in time where we had almost 300 people that could not go to work because of the government shutdown. Those folks are back working now. So it’s almost as if they took vacation and came back on their contract vehicles, so we didn’t recognize that revenue. We didn’t necessarily have all the costs because a lot of people did take time off during that time or took comp time that they went in and made up. But the point is we just didn’t get that revenue because the folks on our T&M-type contracts couldn’t work during the government shutdown, but they are back to work now.

Brian Kinstlinger - Sidoti & Company

Right. I was just trying to understand the sequentially down revenue, which we're not sure about, of course, but the $3 million, if they're back at work, offsets the high-margin -- at least from a revenue standpoint, high-margin hardware sales. So are we seeing further weakness of furloughs or cuts to programs?

John Krobath

We do have one or two contracts which some task quarters have been completed, that were either completed late in Q4 or early in Q1 in terms of work on the government side. That is putting pressure on where we are. We’ve had a couple of contracts where we’ve taken rate reductions as a result of either sequestration or the shutdown in terms of extending funds that are available on contracts rather than reducing staff. We’ve taken rate reductions in some cases in order to support that. So you’re right. You do have a flow back and forth between those $2 million, $3 million items, but as Chris talked about, the software business is generally slower in Q1 than it is in Q4 and we were also impacted by the timing of product shipments where things may have been ordered at the end of Q3 in terms of government spend that we shipped in Q1. That impacts us as well.

Brian Kinstlinger - Sidoti & Company

And at the end of your comments, you mentioned Oracle. And I guess I wasn't sure, are they a development partner? Are they going to be a sales channel partner with all of their ISVs? Len, can you just try to dumb it down for someone like me to understand? What were you trying to get across with that relationship? What it is essentially?

Leonard Moodispaw

It’s early days of the relationship. So right now there’s tooling development of products, partly Hexis and partly on the government side. Where it leads, we don’t know until we finish the development, but it’s a powerful relationship.

Brian Kinstlinger - Sidoti & Company

Got it. Okay. Are you guys able to split the revenue from services and products under the Government piece or is that something you're not going to be doing going forward?

John Krobath

We won’t be doing that going forward. We have become more and more integrated between those two pieces. Really as we’ve brought in the various pieces of the company, Flight Landata being a big piece, but as we’ve done acquisitions such as Ideal and Diligent, Flight Landata, we’ve integrated more and more, so that it was becoming less and less difference in terms of some of the programs that we’re working on. It just made sense as we go to this point with the growth of the commercial cyber work to go back and separate along the Government and Commercial paths.

Brian Kinstlinger - Sidoti & Company

Okay. Last question, a small one. When you guys do become GAAP profitable, what kind of effective tax rate are you looking at?

John Krobath

I would say for a modeling purpose you’re probably using in the 37% to 28% range. It’s complicated as we go through because of the acquisitions we’ve done that impact it. It’s also complicated by the localities in which we’re flying overseas with respect to the Air Services. Every country has a little bit different arrangement, so where that revenue source. But I would say for a modeling perspective if you’re using 37% or 38% you’re probably in the right neighborhood.

Operator

Our next question is a follow up from Stephen Cahall of Royal Bank of Canada. Your line is now open.

Steven Cahall – RBC Capital Markets

Yes. Thank you. Just a follow-up on the pricing of the Hexis sales. I think maybe six months or so ago, we were talking about $500,000 I think was being put around as a potential installation price, and then we had the running price of the user fee going forward. Sounds like now, as you've learned more through the beta customers and the sales channel agreements, it's slightly different. So within that $150,000 to $1.5 million range, can you give us a sense of what the day-one revenue looks like when you ship and install a product, and then what the user fee agreement looks like maybe over a typical life? And just a frame that a bit for us since it is a pretty big range. Thanks.

Chris Fedde

If it's a traditional sale -- and $500,000 of course, is in the middle of that bracket somewhere. If it’s $500,000 sale, we’ll recognize $500,000 when the product is installed or when the product is shipped, excuse me, we’ll recognize it upfront, then there’ll be recurring of either 21% or 25% of that on an annual basis.

Steven Cahall – RBC Capital Markets

And then the range of that, from the $150,000 to $1.5 million, so the $150,000 is just -- is that a smaller unit? Is that less units? What comprises the difference of that up-front revenue recognition?

Chris Fedde

Pricing is -- I think I’m answering your question. The pricing isn’t based on the hardware itself. The pricing is based on how many things in the network we protect. So if we’re protecting a fairly small network, yeah, one set of hardware will be sufficient. If it’s at the larger end, they’re still paying according to how many things we’re protecting. There will be more hardware installed. But their hardware itself does not enter into the pricing equation. We try not to torture our customer with that part of it. They basically pay according to how many things we’re protecting inside their network, then we solve the hardware problem for them as far as what it takes to adequately protect it.

Chris Donaghey

Steve, this is Chris. So the way this works is if you have 2,500 monitored devices that we are going to be protecting, then you’re going to pay X dollars per monitored device and it’s going to be a higher price for a smaller number of devices. When you talk about monitoring several hundred thousand devices, the price per device is significantly lower than what you have with the lower value, but you end up with a total deal size significantly higher because of the total number of devices. The price that you’re referring to was based on an assumption of an average customer that has somewhere between 5,000 and 5,000 or so employees. And what we’re saying is in the pipeline today we have customers who range in total number of employees from significantly smaller than 5,000 to 6,000 employees to potential customers that are significantly higher. So that number that you’re referring to is still a relevant number. It’s just based on an estimated size of who the customer is.

Steven Cahall – RBC Capital Markets

That's great. That makes perfect sense. And if we think about the 20 there in the pipeline now, it’s obvious -- it's a big range, 10 X from top to bottom. Any sense of what the average within that 20 probably looks like if it we're just thinking about what the 2014 average size looks like?

Chris Fedde

I haven’t done any ASP on it. It depends on who’s funds we win at the end of the day. But I would say 500 case probably is about right.

Steven Cahall – RBC Capital Markets

That's great. Thank you. And just one final follow up. Do you have any sense of what the EBIT that was lost from the shutdown, the $3 million in revenue was? You said that you actually didn't necessarily have to keep your overhead through that time, so was it a disproportional loss of EBIT, or was it a relatively proportional loss of EBIT.

John Krobath

Let me tell you what we did and we’ll figure out which way you want to interpret it. When those folks were not working, they were on paid time off. So you’re going to see a $3 million reduction in revenue, but you’re not going to have the cost associated with it because those folks were on leave or if they had comp time or took holiday. So what you’re talking about is the gross margin difference on those guys to be a start. But then what we did with respect to all non-direct billable staff is all of our support staff took off at least one day a week for most of the month of October, if not more than that in order to reduce our costs, at the same time to limit the impact to the bottom line. If you take a look at where we ended up with the EBITDA number for Q4, the effect of those guys taking that time off and as we put it, sharing the pain with the direct folks, was in line with our normal operating costs. So we were able to reduce most of our internal costs to match the loss of the gross margin on that revenue. So I think the impact once you get to EBIT line was relatively minimal at that point.

Operator

Our final question comes from Jared Johnson - SG Capital. Your line is now open.

Jared Johnson - SG Capital Management

Hi, guys. I appreciate you taking the time. Just a couple of questions for you, follow-ups. Is the $20 million or $40 million target for 2014, is that a bookings target or a revenue target just given the mix of the subscription?

John Krobath

First of all I don’t think we said $20 million or $40 million. I can tell you that based on by reading of analyst research that what I see in analyst reports is a range of $20 million to $40 million of revenue for 2013. We will try to be more precise with that. $20 million to $40 million of revenue is what I’m seeing in the research. And what we’re saying is that we intend to try to be more precise with you when we get to the Analyst Day at the end of March.

Jared Johnson - SG Capital Management

Okay, helpful. And is --

John Krobath

I’m sorry, 2014, 2014 revenue.

Jared Johnson - SG Capital Management

For 2015, the $75 million, is that from the sell-side analysts or is that from --?

John Krobath

That is the number that we’ve provided.

Jared Johnson - SG Capital Management

Is that a revenue target, or is that a bookings target?

John Krobath

That was a revenue target. The only caveat that I would say is that our assumption at the time when we put that number out was that it would be 100% perpetual license model. And now that we have begun ramping the business, we’re finding that particularly in the larger deal size cases that customers want to have a discussion about moving to a term license. So I think it’s still a relevant metric, but you’d be looking at a combination of both revenue as well as deferred revenue on the balance sheet by the time we get to the end of 2015 to get a read on that number.

Jared Johnson - SG Capital Management

Okay, helpful. And then the -- just for what you're counting as bookings, are you counting for more than 12 months out or within 12 months?

Chris Fedde

Bookings represent the agreement reached which could be a perpetual license that we recognize upfront or it could be a multi-year as it gets ratable, credibly recognized.

Operator

At this time I'm not showing any further questions. I’d now like to turn the call back to management for any further remarks.

Leonard Moodispaw

And my only remark is good night and thank you.

Operator

Thank you, sir. Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a wonderful day.

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