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Cognos Incorporated (COGN)

F3Q07 Earnings Call

December 20, 2006 5:15 pm ET

Executives

Tom Manley - SVP-Finance and Administration and CFO

Les Rechan - COO

Rob Ashe - President and CEO

Analysts

Mark Murphy - First Albany

Mike Abramsky - RBC Capital Markets

Peter Misek - Canaccord Adams

Steven Li - Raymond James

Steve Ashley - Robert Baird

Tom Roderick - Thomas Weisel Partners

Vik Churamani - Lehman Brothers

John Torrey - Montgomery and Company

Nathan Schneiderman - Roth Capital Partners

Robert Schwartz - Jefferies & Company

Lawrence Rhee - Genuity Capital Markets

Jason Kraft - Susquehanna Financial

Adam Holt - JP Morgan

Presentation

Operator

Welcome to the Cognos Third Quarter Fiscal 2007 Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. (Operator Instructions). As a reminder, we will end today's call promptly at 6:15. We ask that each limit yourself to one question so that everyone has a chance to participate. If we have time left after completing the first round of questions, you may queue to ask an additional question. I would like to remind everyone that this conference call is being recorded on Wednesday, December 20, 2006, and we'll now turn the conference call over to Tom Manley. Please go ahead, sir.

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Tom Manley

Thank you, Rachel. Welcome to our conference call to discuss the company's third quarter fiscal 2007 financial results. Joining me today are Cognos Chief Operating Officer, Les Rechan, who is on the call from our Australian office today; and President and CEO, Rob Ashe here in Ottawa.

For those of you following with the PowerPoint slides from our website, you should now move to slide 2, please. Before I proceed, I would like to caution you that our remarks will contain forward-looking statements relating to, among other things, the assumptions and exclusions underlying our business outlook, future revenues, and earnings on a US GAAP and non-GAAP basis, fiscal year 2008 license growth and operating margins, hiring sales representatives, our operational objectives, opportunities with our alliances, our pipeline, executing on future opportunities, the purchasing environment of our products and product opportunities, including for controller Cognos 8 in our solution, future product releases and market trends, including in performance management, BI standardization, and the office of finance. These forward-looking statements are made pursuant to Section 21E of the Securities and Exchange Act of 1934, and some are considered to provide forward-looking information as defined by the Ontario Securities Act. They are neither promises nor guarantees, but are subject to risk factors that may cause actual results to differ materially from expected results and any conclusion, forecast or projection in the forward-looking statement. A discussion of those risks is contained in our filings with the Securities and Exchange Commission and the Canadian Security Administrators, including our most recent annual report on Form 10-K and quarterly reports on Form 10-Q and in our earnings press release of today's date as well as other periodic reports filed with the SEC. For the purposes of the Ontario Securities Act, certain material factors and assumptions were applied in drawing a conclusion or making a forecast or projection as reflected in certain of those forward-looking statements, and additional information with respect to those material factors and assumptions is contained in the earnings press release of today's date, and provided during this call. Investors should not place undue reliance on such statements, which are currently only as of the day they are made and we disclaim any obligation to update them.

On this conference call, we will also discuss non-GAAP financial measures as defined by SEC Regulation G to provide greater transparency regarding Cognos' operating performance. In particular, we will provide non-GAAP earnings per share, which excludes stock-based compensation expense, amortization of acquisition-related intangible assets, and restructuring charges. Any non-GAAP financial measures discussed should not be considered in an alternative to measures required by US GAAP and are unlikely to be comparable to pro forma information provided by other issuers. Any non-GAAP measures disclosed will be reconciled to the most directly comparable GAAP financial measure in the table provided on the Investor Relations page on our website at www.cognos.com.

Slide 3, please. Cognos delivered excellent third quarter results highlighted by strong license revenue and earnings performance. Total revenue for the third quarter of fiscal 2007 was $247.8 million compared to $212.3 million in the third quarter of last year, an increase of 17%. Net income on a US GAAP basis in the quarter was $16.5 million, or $0.18 per share compared with $24 million or $0.26 per share for the same period last year. Net income for the quarter on a non-GAAP basis was $43.1 million or $0.48 per share, compared with $29.5 million or $0.32 per share last year.

These third quarter non-GAAP results exclude from our US GAAP results $1.7 million of amortization of acquisition-related intangible assets, $7.1 million of stock-based compensation expense, and $26.9 million of restructuring charges all before taxes.

Compared to the GAAP results, this is an increase of $0.30 per share in the aggregate after the affect of taxes. License revenue for the third quarter was $94 million compared to $75.5 million last year, an increase of 24%. Support revenue was $107.8 million compared to $94.4 million last year, up 14%. Professional services revenue was $46 million in the quarter compared to $42.3 million a year ago, up 9%.

GAAP gross margin in the quarter was 76.1% compared with 79.2% last year and GAAP operating margin in the quarter was 5.1% compared with 12.9% a year ago. These differences were due primarily to the restructuring costs incurred in the third quarter. Our non-GAAP operating margin in the quarter was 19.5%, up 3.4 percentage points from a year ago.

Overall, we are very pleased with the significant improvement in our operating performance in the quarter. Overall headcount at the end of Q3 was 3,494, down 168 from the second quarter and down 72 from our third quarter last year.

In the quarter, we successfully implemented our margin improvement program, which resulted in the elimination of 203 positions, offset partially by our continued hiring, primarily in customer facing positions. The company recorded a restructuring charge of $26.9 million in the quarter related to the margin improvement program.

Slide 4, please. We delivered another strong DSO performance in Q3. Day sales outstanding for accounts receivables were 61 days based on any balances, compared to 57 days in Q2 and 66 days recorded one year ago.

Cognos exited the quarter with $599.3 million in cash, cash equivalents, and short-term investments. In the quarter, we saw cash flow from operations of $23.5 million. We repurchased $50 million of stock under our share repurchase program, and we also purchased $16 million of stock to be issued under our restricted share unit program.

Slide 5, please. With regard to our outlook for the fourth quarter, we've assumed an exchange rate of $1.32 for the euro and $0.87 for the Canadian dollar and a GAAP tax rate of 22.5%. With these assumptions built into our outlook for the fourth quarter, we expect revenue in the range of $270 million to $280 million. We expect US GAAP earnings per share to be in the range of $0.54 to $0.60 and non-GAAP earnings per share in the range of $0.61 to $0.67. These non-GAAP earnings estimates for the quarter exclude approximately $1.7 million of amortization of acquisition-related intangibles assets and approximately $6.7 million of stock-based compensation expense, both before taxes.

For the full year, we expect revenue to be in the range of $965 million to $975 million. We expect GAAP earnings per share to be in the range of $1.14 to $1.20 and non-GAAP earnings per share for the year in the range of $1.64 to $1.70. These non-GAAP earnings estimates for the full year exclude, approximately $6.8 million of amortization of acquisition-related intangible assets, approximately $24.7 million of stock-based compensation expense and $26.9 million of restructuring charges, all before taxes.

I'll now turn it over to Les to review the operational highlights of the quarter.

Les Rechan

Thanks, Tom. Slide 6, please. It's a pleasure to participate on this call today and to share my perspective on these very strong third quarter results. Let me begin by reviewing some of the key operational metrics from the quarter, which demonstrate the global teamwork and success we had in Q3.

Slide 7, please. With respect to overall contract metrics, we closed 11 contracts greater than $1 million in the quarter compared with seven in Q3 of last year. We had 140 contracts greater than $200,000 compared with 115 a year ago. Average license order size for orders greater than $50,000 was $222,000 compared with $157,000 last year. It's also worth a special note that the number of license orders over $500,000 increased 108%. These results reflect the very strong large deal execution we saw from our teams around the world.

Slide 8, please. The distribution of license revenue for Q3 was 73% direct and 27% through our partner channel. New business accounted for 23% of our license revenue, with 77% coming from our existing customer base.

Slide 9, please. In terms of our major geographies, 56% of our revenue came from the Americas, 35% from Europe, and 9% from Asia-Pacific. In the quarter, we achieved strong revenue growth in every major geography. For the Americas, revenue growth was 15% driven by 28% license revenue growth. In Europe, revenue growth was 18% in reported US dollars and 8% in local currency. In Asia-Pacific, revenue grew 24% in reported US dollars and 20% in local currency.

Slide 10, please. We ended the quarter with 364 quota-carrying sales reps, down four from a year ago, and down two from Q2. During the quarter, a small number of sales reps were impacted by our margin improvement program, as was our recruiting process for a short period of time. So this is about the number we expected coming out of Q3, and we plan to hire sales reps throughout the remainder of the year, targeting 15 to 20 additional reps by the end of Q4.

Slide 11, please. Let me take a few minutes to provide some additional context and perspective on these results. Those of you who attended our financial analyst conference in October will recall the operational objective I outlined. That is to be the clear leader in performance management by delivering a superior performance management customer experience driving exceptional execution against our pipeline and creating winning conditions for our people. In Q3, we excelled at all three components of that strategy.

Let me review some highlights from each of those areas. Slide 12, please. In Q3, we significantly enhanced our capacity to be the performance management partner of choice for our customers by strengthening our overall solution offering on several fronts. For example, we continued to advance our professional services with the launch of several new initiatives, including a major new training program to equip consultants from our expanding system integrator partner community with deep Cognos training and expertise.

We also continue to grow our portfolio of performance management blueprints in the quarter, with the addition of four new industry-focused blueprints, including the retail promotion planning blueprint, retail bank and customer segment performance, commercial banking customer segment performance, and a US defense program objective memorandum blueprint. Our blueprints and overall solutions approaches played important roles in several successful BI standardization, planning, and workforce opportunities. For example, the strength of our solution set for the life sciences industry was a major influencer in seven-figure BI standardization wins at two top 20 life sciences companies during the quarter. We will continue to enhance our strong solutions focus as we move forward.

Slide 13, please. Our third quarter results also reflects superb execution against our pipeline. In particular, several partnering and marketing initiatives contributed to the strength of our pipeline and our results in the quarter. On the partnering front, we continue to see strong contributions from our alliances with all of our major system integrator partners. In particular, we feel very good about the continued depth and strength of our relationship with IBM. I was also very pleased by the pipeline activity we saw through our performance in 2006 Global Customer road show. Nearly 8,000 customers and prospects attended this 32-city series held around the world. Overall, I continue to feel very good about the strength of our pipeline heading into Q4 and our ability to execute against those opportunities.

Slide 14, please. Above everything else, we delivered this great Q3 performance because our people stepped up and made it happen. In particular, I'm impressed by the heightened level of interlock and team execution I'm seeing around our pipeline.

As I mentioned at the conference in October, this is a priority focus for all 20 revenue-generating units that make up our global operations organization. We've just completed our Q4 interlock sessions around the world using our new Cognos 8 dashboards on top of salesforce.com and our entire team in sales, marketing, alliances and services is focused and aligned around pipeline growth targets and the execution actions for Q4 and beyond.

I should also point out that we have some great new leaders in the company, who are having a strong impact, including Paul Greene, our new Vice President of Services for the Americas, formerly with SAP and Siebel, and Drew Clark, our Vice President of Marketing for the Americas, formerly with Parametric Technologies and Siebel.

In summary, these great third quarter results were the product of superior focus on the performance management partnership experience for our customers, enhanced execution around our pipeline, and tremendous focus and teamwork from our people. I'm confident we will continue to deliver on the opportunity in front of us and now I'll turn the call over to Rob.

Rob Ashe

Thanks, Les. Slide 15, please. Let me start by saying with how pleased I am with these results and the efforts of our team throughout the company. Revenue of $248 million, license revenue growth of 24% all organic, year-to-date license revenue growth now standing at 9%, and strong operating margin expansion in the quarter. These results reflect very solid performance across the key strategic growth opportunities within our performance management vision, and demonstrate the strong purchasing environment we are seeing in the performance management market.

We saw many BI standardization wins for Cognos 8 this quarter with organizations committing to a single BI solution for their enterprise needs. We have won many large deals and the strength of Cognos 8 to deliver in these environments. Recurring scenes in these wins include Cognos 8's 100% web-based capability, our modern service-oriented architecture, the breadth of user coverage, and the extensibility to platform to deliver new capabilities, such as Microsoft Office integration, search, and recently announced mobile addition, Cognos Go! Mobile. These standardization set the foundation for adoption of performance management across the enterprise. The numbers for Cognos 8 speak to the strong demand we are seeing.

In Q3 alone, Cognos 8 delivered license revenue of $60 million. The performance management solutions in the office of finance, following a great second quarter we saw good results this quarter, the high level of cross-selling across our solution, and a particularly strong performance from Cognos Controller. We saw a nice mix of planning-led and controller-led solution contracts, as well as a very high attach rate of BI to these opportunities.

Our controller presence continues to grow in North America, with more wins and more competes, giving the confidence that we will continue to expand the opportunities in this market. And again this quarter, we saw a strong pick-up of our recently-released workforce performance application as we signed another multi-million dollar partnership agreement, this time with IBM. With this agreement, IBM has committed to include workforce performance in its human resources business, transformation and outsourcing, workforce analytic solution. Three of the world's leading HR outsourcers have committed to our workforce performance application. These results reflect a balanced performance across our entire performance management platform, with particular strength this quarter in business intelligence.

Slide 16, please. I remain confident in our strategic position based on the key trends we are seeing in the market from our customers and prospects, and these results reflect the positive outcome of the important decisions we have made to capitalize on those trends. First of all, performance management is the theme that resonates with the business buyer as all of our customers and prospects are looking to deliver more value to their organizations through better insight, understanding, and action.

Second of all, BI standardization as a platform for performance management is in full swing with IT buyers looking to make BI pervasive across the organizations in support of these growing business demands. This trend of BI standardization combined with a platform shipped to service-oriented architectures has put Cognos 8 in a unique position as a solution of choice for standardization across large organizations.

And lastly, performance management, driven through the office of finance continues to be a catalyst for financial transformation. Through more effective systems for planning, more cost -- more efficient close and consolidation process, or simply through more effective use of BI and finance for communication of financial results, the office of finance continues to invest to drive the transformation. We believe that our continued leadership position in Gartner's new CPM Suites Magic Quadrant is a testament to the strength of our position and opportunity in this market.

Slide 17, please. After a year of significant transition on the product front, we believe we are heading into a period of strength for our entire solution with enhancements planned across the platform. Cognos 8 MR2 shipped in July was a significant improvement over MR1 in terms of quality, performance, and upgrade. We've also recently released Cognos 8 support for salesforce.com, giving Salesforce customers the full range of Cognos ReportNet analysis capability, tightly integrated into the SFPC environment. We have already seen our first significant win in the market with this release this quarter.

We're planning to deliver the next release of Cognos API this quarter, Version 8.2. Our focus continues to be on quality, performance, and improved upgradeability. We're also continuing to strengthen our market-leading operability with SAP. Early feedback on this release is great. We continue to see the mix of applications that our customers are developing with Cognos 8 weighted toward new application development with a steady stream of upgrades making up the remainder. At this stage, our penetration of Cognos 8 into our installed base remains relative low and represents a significant ongoing opportunity as we continue to grow the opportunity for upgrades with product enhancements, utilities, and service offerings.

Cognos 8 Go! Mobile, our exciting new extension to Cognos 8 is expected to ship in February. My own personal dashboard, which I showed many of you at our October analyst conference is, now delivered to me every 15 minutes via Cognos 8 Go! Mobile when I'm on the road. This is a very exciting new application. The additional enhancements planned for solutions in the office of finance, we believe we have a very strong product cycle ahead of us across the board inevitably to help us achieve our goals in Q4 and into FY '08.

Looking forward, while we won't provide FY '08 guidance today, broadly speaking our planning parameters for fiscal year '08 include revenue growth of 10% and operating margins of approximately 16% on a GAAP basis and approximately 20% on a non-GAAP basis.

To conclude, we have delivered strong results here in our third quarter and we enter our fourth quarter with a healthy pipeline. I want to thank all of our employees for their continued passion, teamwork, and customer focus. Because of their efforts, we're now off to a great start in the second half and remain very confident in our business. Operator, we'll now open it up for questions.

Question-and-Answer Session

Operator

Thank you. One moment, please. (Operator Instructions). Your first question comes from Mark Murphy from First Albany, please go ahead.

Mark Murphy - First Albany

Thank you. Congratulations on a strong quarter. Rob, it looks like you are guiding us toward 10% revenue growth in FY '08, which is above the consensus of 8% currently. And you've also commented on a likelihood of growing license revenue double digits. o the question is, are we expecting license support and service revenue are all going to grow at a 10% rate going into FY '08, or can you help us to think through whether there would be some variation by revenue line?

Rob Ashe

Mark, we think it will be pretty consistent of 10% on each of our revenue streams.

Mark Murphy - First Albany

Thank you. Then just as a follow-up, you do have a tough year-over-year license revenue comp coming in Q4. When you consider the pipeline, what is your comfort level in achieving the consensus, which is around $115 million right now for license revenue, or is there an opportunity to exceed that?

Rob Ashe

Well, we've said -- I'll hand it over to Les in a second just to talk about the pipeline going into Q4, but we've set guidance that we're pretty comfortable with, I think represents good performance exiting FY '07, and that's kind of where we expect guidance to be right now. We don't want to be changing that. So, maybe I'll just pass it over to Les in terms of how he's feeling about the pipeline going into Q4.

Les Rechan

Yeah, we're not providing specific metrics on the pipeline, but I will tell you that it's strong overall. Coverage has been growing. We see a healthy mix of deals of all sizes and I feel good about our overall opportunity and customers, as you see, in the large deals are picking a partner here. And I would say that qualitatively, we've got great team focus on the pipeline and execution against the pipeline across all functions, sales, pre-sales, services, marketing. We've got strong close plans in place. We've instituted that discipline for end-quarter deals and we've got a strong focus on coverage going forward in the quarters beyond into '08. So I'm feeling pretty good about where we sit at the moment.

Mark Murphy - First Albany

Thank you.

Operator

Your next question comes from Mike Abramsky. Please go ahead, sir. Mr. Abramsky?

Mike Abramsky - RBC Capital Markets

Can you hear me?

Operator

Mr. Abramsky?

Rob Ashe

We can hear you now, Mike.

Mike Abramsky - RBC Capital Markets

Okay, thank you. Either Rob or Les, could you guys give us a sense of where you are in the C 8 cycle and how long you see that progressing, and what those assumptions are. Are you still at the early stage vis-à-vis, customers at the trial and beta stages in the majority of cases, or are you starting to hit a stride? How long do you think that is going to take -- can you just give us a little bit of flavor as to what's going on with regards to C 8 and the timing?

Les Rechan

I'll take that, Mike m I think we're still early. I think we're into our second maintenance release, the third kind of major release, say 8.2 shipping in February. Our penetration into our base of reporting it and Cognos 8 together is only around 20%. I think we're very, very early in our overall cycle. We're seeing this trend towards standardization amongst companies as we talk to our customers and read surveys of the broader market, upwards to 8 of the 10 large companies looking to standardize and not having got to that point yet, but considering standardization, I think we're early in the cycle. I think there's lots of opportunity, I think more and more people are associating these kind of deployments now with performance management, which gives an opportunity to position a broader solution set. So, I think we're still early in the Cognos 8 cycle and we're optimistic about how we continue to drive that cycle.

Mike Abramsky - RBC Capital Markets

And the second part of my question, regarding your assumptions next year is to sort of penetrating the market, upsell, cross sell for C 8, driving your 10% planning growth?

Les Rechan

There's no specific assumptions we're making at this time. We're not setting guidance. We just thought it was wise to give a broad parameter. So, when we announce our Q4 results in March, we'll give you a little color to our assumptions.

Mike Abramsky - RBC Capital Markets

Okay. Thanks.

Operator

Your next question comes from Peter Misek from Canaccord Adams. Please go ahead sir.

Peter Misek - Canaccord Adams

Good evening, gentleman. If you could help us out understand M&A chatter, if, when, where and how? Any color would be appreciative. And also, particularly, on the moves by Oracle and others to say that they may or may not want to have the same level of BI and performance management that you folks and your peers do? Thank you.

Rob Ashe

Peter, we make it a practice not to comment on specific rumors, so we won't comment on whatever chatter you might be referring to. We've driven a great quarter here, we continue to drive -- we intend to drive another good quarter. So we're not going to comment on specific rumors.

Peter Misek - Canaccord Adams

Can you help us out, then, in competitively, Oracle and Microsoft appear to be attacking the market, your core markets, from different perspectives. Microsoft on the low to mid-end according to some surveys appears to be getting a lot of tractions and hurting some of your peers. Can you help us understand that dynamic and maybe if Oracle has been having any impact on the mid to lower end of the enterprise market?

Rob Ashe

I think we've said for some time probably, five or six quarters now that we think all these folks now have woken up to the value of the BI market, its importance in terms of -- just BI in its own right, performance management more broadly and all of them are trying to participate in the market. Pretty much acknowledged, Microsoft competes more aggressively at the low end than the high end and I think at the high end, Oracle and SAP are both trying to play in the market. We feel great about the sustained value of an independent play because of the independence from data sources, independence from infrastructure, the 100% focus on business intelligence, which gives us the opportunity to really stay ahead from an innovative perspective. So I expect that all those larger players are going to be continue to be interested, but I think we have good competitive position and we're going to continue to drive that in the market.

Peter Misek - Canaccord Adams

If I may just one quick follow-up, has there been any change in the last quarter, pricing or aggressiveness by any of the big players, not just for me. Thank you, and have great holidays.

Rob Ashe

Les, do you want to comment on that pricing question?

Les Rechan

Yeah, I would say, overall, as it relates -- kind of picking up on what Rob said. The noise from the players has increased. We continue to see customers choosing us for the depth of our ability to work heterogeneously with various dale sources and systems and the breadth and richness of our solution and domain expertise really helps win the day if you will from a partner perspective for the customer. So, we feel pretty good about our ability to engage and win and from a pricing point of view, I haven't seen any dramatic impact of that. We really are into the pervasive performance management opportunity with our customers. The various customer sets that we have are growing, including SMB. So we're not resting on our laurels here. We've got a lot of work to do across the board on the things that I have been walking talking to you and we will continue to do that.

Operator

Your next question comes from Steven Li from Raymond James. Please go ahead.

Steven Li - Raymond James

Thank you. First question for Tom, if you look at your services after the restructuring where do you see the services margin going next year? And maybe you can talk about the different moving parts, Tom?

Tom Manley

Services margin on a GAAP basis, obviously were impacted by the restructuring, so on a non-GAAP basis service margins came in around 15.3%. So a little bit lower than the mid to high teens that I was expecting this quarter, but still not that bad. We are down sequentially in revenue from Q2 slightly, mostly in the education area, which cost us a little bit on the margin side. But having said that, we're not unhappy with the performance as we continue to transform our model on a global basis, and we're confident that our overall performance will continue to improve. I'm expecting modest improvement through to yearend, and hopefully around 19 or 20% in fiscal year '08.

Steven Li - Raymond James

Okay, thank you. And just one more question for Rob. When you were talking about the Cognos 8 cycle, have you had better success in term of migrating the power play customers?

Rob Ashe

I would say not yet. I would say that power play customers, series 7 customers, generally are quite happy. As I've said many times, we've had quite a very successful upgrade to series 7 from all the previous releases. They're seeing better interoperability with Cognos 8, now and through 8.2. So it will continue to make the interoperability better, make them more comfortable, and get them moving ultimately as we continue to provide better capability for them, but I wouldn't say we're seeing it improve yet.

Steven Li - Raymond James

And do you expect the Version 8.2, is that going to help on that front?

Rob Ashe

I think will help with interoperability, as well more education on interoperability will help as we go forward here.

Steven Li - Raymond James

Great. And then how much revenues was from Cognos 8 in Q3?

Tom Manley

$60 million.

Steven Li - Raymond James

60, thank you.

Tom Manley

Sorry, license. $60 million in license, yes.

Steven Li - Raymond James

Thanks.

Operator

Your next question comes from Steve Ashley from Robert Baird. Please go ahead.

Steve Ashley - Robert Baird

I was just wondering if you could comment on your sales force performance. If you look at the GMA sales force versus the mid-market and how they might have done year-over-year?

Rob Ashe

Les, did you hear that question?

Les Rechan

Yes, I did. We don't provide a year-to-year comparisons here. I can tell you that global major accounts continues to grow substantially year-to-year, and in particular, life sciences had a very major year in accounts and we'll continue to refine our segmentation here for global major accounts and improve our overall delivery model to customers. So, that's kind of a work in process. The SMB business continues to meet our internal plans. We're driving profitability there, we're not doing a mass market approach. We're focusing on customers with complex data requirements, and I'm pleased with our channel's business performance, which include SMB. It includes our OEM business, is doing well. It includes Latin America. So I think as we go forward, we're just going to continue to scientifically refine our segmentation, refine which sweet spots we go after market by market here, globally. I talked about 20 revenue-generating units. We're looking at what I call market views for each of those units and really pinpointing where the opportunities are market by market and really aligning our resources accordingly to capitalize on those opportunities and most importantly serve customers in the right way within those customer sets.

Steve Ashley - Robert Baird

Great. Thank you.

Operator

Your next question comes from Tom Roderick from Thomas Weisel Partners.

Tom Roderick - Thomas Weisel Partners

Hi, good afternoon. Thank you. Tom, last quarter on the conference call, you commented that you were looking to add approximately 20 to 25 sales heads in the back half of the year, and now a quarter later with two less direct sales heads, you're targeting 15 to 20 for the whole year. Any reason for the reduced outlook in terms of the numbers of heads that you looked at? Are you seeing greater efficiency out of the heads you have here?

Tom Manley

Well, I'll let Les comment on that in a second, but we knew that the hiring of these sales reps would be back-end loaded in the second half and we did have the restructuring activity that happened early in the quarter, which really diverted our attention away from some of the key hiring activities for at least a month or two, and we're just being a little bit realistic in terms of what we think we can accomplish over the next three months. Certainly we do not intentionally lower the year-end projection, but just given where we are in the short time between now and the end of February, that's kind of where we think we're going to end up. Les, do you have any other comments you want to make?

Les Rechan

Yeah, I would just say that overall, the recruiting engine now is primed here and attrition is flattening out. I think that as we look at future quarters, I think it's important to point out that we've improved our ability get reps up to speed and get them to productivity faster here. So we're -- I think we've -- we're very focused on this, this capacity issue, not because we -- we really want to position ourselves to capitalize on the strong opportunity we see in front of us here, not necessarily to meet our current revenue goals, but that's what I would say here. I think that coming out of Q3 with the decent performance and looking at the full year here, the team is really primed to execute and they're focused on the opportunity in front of them.

Tom Roderick - Thomas Weisel Partners

Okay, good. And maybe just even looking beyond just the next quarter, thinking about this parameter of 10% growth you've identified for next year, would you see the need to continue to add heads at a pretty aggressive clip in the first half of the year, or do you think that adding another 15 to 20 here in the fourth quarter leaves you with the appropriate coverage going into next year?

Rob Ashe

Tom, we're not ready to comment on that kind of detail for next year at this stage.

Tom Roderick - Thomas Weisel Partners

Okay, great. Maybe one last follow-up for you, Rob, just on Version 8.2. Can you give some detail regarding when that is formerly -- when that formally comes out, and maybe just a little bit more detail around how that assists your customers from a migration standpoint to Cognos 8?

Rob Ashe

Well -- it's in beta today, it's been in beta for a little while, it's expected to ship at the end of February. It is really focused on continued improvement in quality and performance, as customers my migrate and upgrade and we determine what bugs are, what in the way we fix those, so the next time the customer tries to do the same thing, it's easier. So it's just the accumulation of experiences with our customers, that finds its way into the product. Cognos 8 Go! Mobile is an important part of that release, as is kind of the inclusion in the infrastructure of Cognos Go! Search, which we announced back in the spring of adding kind of an early release since then. So there's a lot of good stuff in the release.

Tom Roderick - Thomas Weisel Partners

Great. Thank you very much.

Operator

Your next question comes from Vik Churamani from Lehman Brothers. Please go ahead.

Vik Churamani - Lehman Brothers

Nice release and a good quarter. A couple of questions, Rob. When you talk about 10% or double-digit type license growth for next year, should we expect some tuck-in type acquisitions looking out to fiscal '08? And then also, if you can comment on Europe, your performance was pretty good. If you look at your competitors, one of them was also pretty bullish recently at analyst day and another one is looking to recover some of the growth in that area. Could you just comment as to what the environment in Europe right now?

Rob Ashe

I'll take the first part. Vik, repeat the first part of the question again.

Vik Churamani - Lehman Brothers

The double-digit license growth for next year, should we expect some tuck-in type acquisitions?

Rob Ashe

Oh, sorry, yeah. I will anticipate that we will have some modest addition, but nothing significant at this stage in those planning parameters. So it would be -- if anything was included, that would be something small. With respect to Europe, Les, could you take the Europe question?

Les Rechan

Yeah, I think Europe did have a good quarter. We've got some new leaders in there that are doing a great job, specifically in Southern Europe (inaudible). We've got a new guy in Holland, who has been with us now over a year. Karel Kinders who came to us from Siebel, doing a great job. So, as you look at that business, the north region, the Nordics, etc. are doing well, south doing well, UK doing well. I want to focus on Germany more. We've got new leadership there, who's very familiar with that market and so Europe, we just need to stay focused and continue to execute. I think there is an opportunity there. I'm pleased with what the team did this quarter and we want to stay on that case going forward.

Vik Churamani - Lehman Brothers

Great. One last follow-up for Tom. Tom, you talked about 19% to 20% services margins. If I look at a similar sort of growth rate for OpEx for fiscal '08, which is roughly about 6% for next year and then also for this year, I mean, it seems like your earnings expectations are coming more to like 25% earnings growth. Does that sound reasonable, or are we off in our math here?

Tom Manley

We're not prepared to talk in a lot of detail regarding the plan next year. I think that generally as we go into this planning cycle -- and I'm sure your models will be able to back into these numbers, we're expecting pretty consistent revenue growth across the three segments of revenue -- license, support and services and certainly expect to have 20% operating margin on a non-GAAP basis.

Vik Churamani - Lehman Brothers

Great, congratulations.

Operator

Your next question comes from John Torrey from Montgomery and Company. Please go ahead.

John Torrey - Montgomery and Company

Good afternoon. Just a quick follow-up, Les, on something you said earlier regarding coverage rates. You indicated that you had seen them growing and you are going to remain focused on that. Could you just elaborate on what trends you're seeing then in close rates, or what assumptions you're making about trends in close rates given the outlook over the next year?

Les Rechan

In terms of -- we don't release specific close rates, but as I mentioned before, what I'm really pleased about here is that the entire company is really focused on pipeline growth. And I don't want to assume dramatically higher close rates. I want to get a strong pipeline with a good mix in the current quarters. I want to treat every month like a quarter, have very high quality close plans that deliver the value for the customer and create a win-win situation. I can just tell you that we have implemented increased discipline here, even down to the SFA system itself, where when you get to a certain point in the cycle, there's a quality assurance that goes on between the actual rep and the manager around the close plan, so that we're realistic in terms of what it's going to take. Again, with very much of a performance management partnership orientation with the customer, so we're just coming out of the Q4 interlock sessions where we get everybody in these 20 revenue-generating units focused on this across all the functions and they have clear targets down to the rep level, as well as each function, so marketing, services, sales, everybody has got pipeline targets and so that's really what we're focused on, is building that healthy pipeline capability and then assuming that we collectively, as a team, can go out and gage and win with the value and the differentiation that we have as a company.

John Torrey - Montgomery and Company

Okay, but I mean, I guess, overall, given your color around coverage ratios, is the net of that has to be that you seem to have more conservative assumptions about close rates. Is that a fair assumption --

Les Rechan

More conservative? Did I hear you say -- I didn't hear, did you say conservative?

John Torrey - Montgomery and Company

Yes. About close rates.

Les Rechan

I would, frankly, going forward -- yeah, if you do the way that works, the answer would be yes, but I want to assume that, in fact, we can get better at that in the game that we're playing now, which is an environment where customers really are looking to differentiate with this type of capability, and because we've got a lot of the raw materials that they need around the Cognos 8 foundation and the other things that Rob talked about, I would hope that we could deliver the same close rates, if not better against a healthier pipeline. So that's kind of the way we're working this.

John Torrey - Montgomery and Company

Thank you.

Operator

Your next question comes from Nathan Schneiderman from Roth Capital Partners. Please go ahead.

Nathan Schneiderman - Roth Capital Partners

Hi. Thanks very much. Congrats on the quarter. Hopefully this is the start of another four-year run of good quarters.

Tom Manley

Thanks, Nathan.

Nathan Schneiderman - Roth Capital Partners

Yeah. A couple of questions for you. Tom, I was hoping you could detail FX impact. How much did that lift revenue, lift expenses, and the impact on the operating profit?

Tom Manley

The year-over-year, the impact was about $8 million on total revenue, and it was about $8 million on expenses.

Nathan Schneiderman - Roth Capital Partners

Okay. And then, just on the big deal front, can you clarify, did you have any eight-figure deals, and how many deals were $5 million or above?

Tom Manley

No, we had no eight-figure deals, and we had several large deals, but we are not going to disclose how many were 5 or 4, or 3.

Nathan Schneiderman - Roth Capital Partners

Okay. And the final question, for Tom, just so that I'm clear and don't get crazy on the numbers at the bottom, it sounds like you're okay with about $1.07 billion for fiscal '08, and you're a little above $2 on the bottom line. Am I doing the math right?

Tom Manley

Well, we're not that far along in terms of providing that kind of guidance, so you'll have to do your models to reflect what you think the numbers are

Les Rechan

What we try to do, Nathan, at this stage a broad planning parameter.

Nathan Schneiderman - Roth Capital Partners

Okay. Thank you very much.

Les Rechan

Okay, Nathan.

Operator

Your next question comes from Robert Schwartz from Jefferies & Company. Please go ahead.

Robert Schwartz - Jefferies & Company

Thank you very much. Les, looking at the numbers, it looks like you had really dramatic success between the $500,000 and $1 million range. Also this quarter, there seem to be more business with existing customers. Help us understand why that seems to be the sweet spot and does that look like the sweet spot going forward in Q4 and beyond? Why are you having success at those points?

Les Rechan

I think it's a function of a lot of things here. I think that customers, as I mentioned, are really looking to differentiate with performance management. They're looking to move it across functions and enterprises, and they're looking to pick a partner here. Some of the trends that Rob talked about. I am pleased with the way our team engaged these deals in this range and I mentioned the stats on the 200K and above, as well as the 500K and above, the dramatic triple digit increase there on the 500K and above. I think that we have the right approach here. And this is something that is, again, I would call it work in process that we're going to continue to focus on, is getting the right alignment with the customer around what they're trying to do. The performance management blueprints really help here in terms of drilling down into the pain points. What is the customer trying to do in each function and in each division, provide the right solution staff to meet those requirements with partners, as well, provide a good solid management system around that for how we will execute on an ongoing basis and give them the flexible access to the technology that they require. Those are the ingredients that make this up, and I think the team is really engaging well here and we have to work at this every day, because the bar gets higher every day working with customers and what they expect, but I am pleased with the progress that we're making here. I think we're putting one step in front of the other.

Robert Schwartz - Jefferies & Company

And if I may have one follow-up. You'd mentioned strength with the partner channels and the SIs. This quarter, it seems that third party sales were no different than it had been in the past. I'm wondering, would you expect to see that tick up going forward?

Les Rechan

Yeah, there's -- in terms of the SI influence, that would not necessarily show up in the revenue coming from the channel, if you will. Because it doesn't show up in that number. I can tell you that out of our big deals, two-thirds of those were influenced by partners. Some global system integrators and some local solution providers. So, I feel very good about the engagement and the alignment. Our partner alignment is showing up within our market view plans and our industry plans and we're looking at creating solution sets with partners. For example, with IBM, we've got the crime information solution set, we've got the risk management for banking solution set, we've got this workforce performance solution set. We're positioning that well. And then in terms of the channel drive, I think that we really do want to continue to enhance the focus with solution providers, which where that revenue shows up, as well as with OEMs, and next generation OEMs, software and service providers, BPOs, et cetera. So I would like to see us have more influence on every dollar of revenue, because I think it helps deliver the value to the customer, and then as well as exploit the next generation opportunities with partners, who would be, if you will, reselling our solutions embedding Cognos and powering their solutions with Cognos. I think that -- I'm really positive about that opportunity going forward as well.

Robert Schwartz - Jefferies & Company

Thank you.

Operator

Your next question comes from Lawrence Rhee from Genuity Capital Markets. Please go ahead, sir.

Lawrence Rhee - Genuity Capital Markets

Hi, guys, good quarter. I just wanted to ask you about -- just another way of looking at that previous caller's question regarding new and existing license revenue, maybe can you just add some color around the kind of new, kind of percentage of 23%. Is it competitive pressures on that side or is it kind of sales force, kind of strategy internally, just if you can add some color on that?

Rob Ashe

All that takes is one or two upgrades deals into Cognos 8 from some of our big customers, and boom, the number changes. So, there's no reflection there of competitive dynamics. If there is any change there it's just the opportunity within our base to upgrade people to Cognos 8. A significant transaction can skew that number quite quickly. So, there's no competitive dynamics behind that number.

Lawrence Rhee - Genuity Capital Markets

Also, I just looked at the trend of that new license revenue number over the past three quarters, it's basically been flat to negative growth over the past few quarters, so it hasn't shown growth year-over-year yet. Are you expecting, I guess, new customer growth, assume, eventually over the next couple of quarters?

Rob Ashe

We continue to get good, solid new customer wins, but we do spend a lot of time in our base, given Cognos 8 is a great upgrade for that base. We do a lot of base marketing. As Les said, elevating our relationship with these customers to performance management partner from your supplier. So the dynamics of the market, that we do, the organization of the GMA group around our base we really view it as the penetration of new accounts continues to be quite low, and I think there's an opportunity there. So, I wouldn't take anything away from that number in this quarter.

Lawrence Rhee - Genuity Capital Markets

Okay. Thanks, guys.

Operator

Your next question comes from Jason Maynard with Credit Suisse. Please go ahead, sir. Mr. Maynard? Mr. Maynard, please go ahead.

Rob Ashe

Operator, you might as well move to the next question.

Operator

Your next question comes from Jason Kraft from Susquehanna Financial. Please go ahead.

Jason Kraft - Susquehanna Financial

Thanks, Susquehanna. Most of the questions have been answered, but just ask this question another way. Eleven deals are over 1 million, how many were considered abnormally large, how many are over 3 million, how many are over 5. I'm sure you won't answer, but we'll take a shot here.

Rob Ashe

Well, we don't give that detail, over 11 deals, we had -- our average order size was up to $220,000 from $157,000 last year, so we had good performance in deals over half a million dollars, for sure, but we don't provide the specifics on what deals were what size.

Jason Kraft - Susquehanna Financial

And just quickly, license revenues seasonality on a quarterly basis this year. Should we use that as kind of a benchmark for modeling next year?

Rob Ashe

At this stage, I don't know why you wouldn't --

Les Rechan

Well, we are a little stronger in the second half, but we haven't really gotten into our planning cycle yet, so it's difficult for us to even comment on that, Jason.

Jason Kraft - Susquehanna Financial

Thanks.

Operator

Our last question will be from Adam Holt from JP Morgan. Please go ahead.

Adam Holt - JP Morgan

Hey, guys. Happy Holidays.

Tom Manley

Hey, Adam.

Adam Holt - JP Morgan

Rob, my first question is for you. We've talked a little bit over the last few quarters about the negative influence of power play on license revenue, do you think that power play bottomed in this quarter, maybe give us a sense for the contribution and how important is the 7.3 lease going to be to that line item?

Rob Ashe

Well, I don't know if it bottomed or not, but all I can reiterate is that we have an opportunity through showing better interoperability with Cognos 8, showing a better path to Cognos 8 with 7.3, all these things just to reinvigorate our confidence in power play in that base and to get people investing there. At this stage, given our performance over the last four quarters, it just represents upside for us if we can do a better job of getting people investing either in power play in its current form, or working with Cognos 8. So it's an opportunity for us for sure.

Adam Holt - JP Morgan

And if I could close with one housekeeping question for Tom, if you're looking at the cash flows, you had a pretty significant positive impact from salaries commissions and related items. Is that presumably some accruals related to the reduction in force, or maybe you could help me with what was behind that number?

Tom Manley

Yeah, so on the balance sheet, the salaries and commissions, that's where almost all of the restructuring charge ended up on our balance sheet. And I believe that we have about -- I'm going to say about $16 million left to pay out on that going forward.

Adam Holt - JP Morgan

Okay. Maybe -- I lied, just one more associated question to that derivative. R&D was down sequentially, presumably again that was related to the restructuring. Should we be thinking about the number in the third quarter, the baseline for the fourth quarter, or will that number continue to move lower to the extent that maybe you had some intra-quarter cuts that didn't fully get reflected in that number?

Rob Ashe

We don't specifically talk about individual lines on the P&L, but we're still maintaining the strategy, post our restructuring activity for investing in what I would call customer-facing people and fairly limited growth in other areas of the business, though we have some hiring planned in R&D. But our focus is really in customer-facing positions.

Adam Holt - JP Morgan

Great. Thanks very much.

Rob Ashe

Okay. I would like to thank everybody for joining us tonight. I wish everybody the best of the holiday season and I look forward to catching up with you in the New Year. Bye-bye.

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Source: Cognos F3Q07 (Qtr End 11/30/06) Earnings Call Transcript
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