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CommVault Systems Inc. (NASDAQ:CVLT)

F3Q08 (Qtr End 12/31/07) Earnings Call

February 5, 2008 5:00 am ET

Executives

Bob Hammer - Chairman, Presidentand CEO

Al Bunte - COO

Lou Miceli - CFO

Michael Picariello - Director IR

Analysts

Tom Curlin - RBC

Fred Reid - Goldman Sachs

Aaron Schwartz - JP Morgan

Brent Bracelin - Pacific CrestSecurities

Aaron Rakers - Wachovia Securities

Marks Griffin - Thomas Weisel Partners

Dennis Simpson - Credit Suisse

Dan Renouard - Robert W. Baird

Steve Koenig - KeyBanc CapitalMarkets

Operator

Good day, ladies and gentlemen.Thank you very much for your patience and welcome to the CommVault's fiscalthird quarter 2008 Earnings Call. At this time all of our participants are in alisten-only mode. Following today's presentation, instructions will be givenfor our question-and-answer session.

At this time, for opening remarksand introductions I would like to turn the call over to Mr. Michael Picariello,Director of Investor Relations. Please go ahead sir.

Michael Picariello

Good afternoon. Thanks fordialing in today. With me on the call are Bob Hammer, Chairman, President andChief Executive Officer, Al Bunte, Chief Operating Officer, and Lou Miceli,Chief Financial Officer.

Before we begin, I like to remindeveryone that statements made during this call including in the question-and-answersession at the end of the call, that relate to future results and projectionsare forward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995 and are based on our current expectations. Actualresults may differ materially due to a number of risks and uncertainties, whichare discussed in our SEC filings in the cautionary statement contained in ourpress release and on our website.

The company undertakes noresponsibility to update the information in this conference call under anycircumstances. Our earnings press release was issued today over the wireservices after market closed and it also has been furnished to the SEC as an 8-Kfiling. The press release is also available on our Investor Relations website. Onthis conference call we will provide non-GAAP financial results. Thereconciliation between the non-GAAP and GAAP measures can be found in Table IVaccompanying the press release which is also posted on our website.

This conference call is alsobeing recorded for replay and is being webcast. An archive of today's webcast willbe available on our website following the call.

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

Bob Hammer

Thanks Michael. I would also liketo welcome everyone to our third fiscal quarter of 2008 earnings call. We hadanother record quarter as we continued to make progress in achieving our long-termstrategy for the company. We had strong performance from our internationaloperations and we made excellent progress in increasing our market penetrationof our non-backup or emerging products. In addition, we recently launched ourfirst SaaS offering which we call Remote Operations Management Service or ROMSfor short which I will talk about later in the call.

The demand for our Simpana 7.0Software Suite remains very strong and it has fully helped us accelerate thegrowth of emerging products as well as strength in our position in our coredata protection business. Specifically we have seen strong demand forarchiving, single instancing, data classification and search.

We continue to outperform ourcompetition and increase our market share. For the quarter, we achievedrevenues of $50.3 million, up 31% on a year-on-year basis, versus $38.3 millionin fiscal Q3, 2007. Software revenue grew on a year-on-year basis by 28%, whileour services business grew 36% year-over-year.

For the quarter, non-GAAPoperating income or EBIT was $8.6 million, up 51% year-over-year versus EBIT of$5.7 million to the same period a year ago. Non-GAAP net income was $6.9million for the quarter and non-GAAP earnings per share was $0.15 for thequarter. Our CFO, Lou Maceli will provide more details on the quarterly financialresults later in the call.

I will address deal stats first.We added 389 new customers in the quarter. As usual new customer adds did notinclude a large number of small orders from new OEM customers who registeredthrough the internet. Our customer base now totals approximately 7,500 whichdoes include the OEM customers who registered thorough the internet. We hadsolid growth across both our backup products as well as accelerating sales ofour emerging products. For Q3 2008, sales of non-core backup or emergingproducts increased to approximately 26% of software revenue versus 23% in Q2 '08versus 16% in Q3 of last year. Growth in sales of our merging products havebeen primarily driven by new components of our Simpana 7.0 Software Suiteincluding single instancing, advanced archiving, enterprise wide search, anddiscovery and data classification.

As we continue to makesignificant progress in expanding our market positions above core backup andemerging products in fiscal 2008, we expect the percentage of our emergingproduct sales to increase as a percentage of total revenue over the medium tolong-term, however we still expect that this percentage will continue tofluctuate quarter-to-quarter in the short-term.

We see broader deployment of ourfull suite of products and larger deals. In deals, over $100,000 sales of our emergingproduct represent approximately 33% of the sales. This is continued validation thatour customers like our singular approach to the market and is a significantpart of the growth and sales of our emerging products. Our customers arepurchasing multiple elements of the Simpana Suite.

Our singular approach to themarket is residing with the customers and with experts in the industry. Thejudges that searched storage.com announced this morning that our Simpana 7.0Software Suite received the Gold 2007 Product of The Year Award for backup and disasterrecovery software. A quote from the search.storage announcement is as follows.

"Simpana is at the vanguardof the long awaited consolidation of data protection apps. It involves backuparchiving replication including CDP, [de-dup] search and data managementreporting into a single package.

In the third quarter of fiscal2008 approximately 33% of our software revenues came from deals over $100,000compared to 37% of software revenue generated from deals over $100,000 in oursecond quarter of fiscal 2008, and compared to 30% in the third quarter of lastyear. All though deals over $100,000 as a percentage of revenue declinedsequentially they were actually immaterial higher number of deals greater than$100,000 than last quarter.

The number of deals greater than$100,000 were up 47% in Q3 FY '08 versus same quarter a year ago. We continueto see an increase in our visibility to big deals as we continued to takemarket share. We continue also to anticipate that about a third of our softwarerevenue in the medium-term could come from deals greater than $100,000.

I will now address geographicrevenues. On the geographic front the United States operations generated63% of our total revenues in the quarter, with operations from the rest of theworld generating the remained 37%. We continue to expand our internationaldistribution with strong growth in Europe, Australiaand Asia.

Revenue from foreign locationswas up 86% in Q3 FY '08 versus same quarter a year ago. We continue to besuccessful in broadening our distribution reach and have recently announced anew resale agreement with Sun, which I will talk about in a few minutes.

Let's talk about channelrelationships and distribution. We continue to have strength across all of ourdistribution channels with good contributions from our OEM partners, resellersand systems integrators. We continue to build out and strengthen ourdistribution channels as this is key to our growth strategy.

Now I'll talk about Dell. Salesthrough both our OEM and SMB relationship with Dell accounted for approximately23% of total revenues in the third quarter of fiscal '08, with the breakupbeing 6% OEM and 17% SMB. We continue to see strength through multiple salesegments within Dell globally. We are seeing significant traction globallyacross all lines of business in storage hardware. Our partnership with Dellcontinues to grow stronger, we continue to make progress and discussions withDell regarding the expansion of our relationship.

Regarding HDS, we saw asignificant increase in license revenue from Q3 FY '07 particularly ininternational markets. Our relationship in business with Hitachi Data Systemscontinues to develop as we refine our distribution strategy and improve ourbusiness execution.

Sun, as you have recently seen inour recent announcement a week ago, we have entered into a formal worldwideresale agreement with Sun Microsystems. We expect this relationship to provideus access to Sun accounts and customer's interest in running Microsoft Exchangeand SharePoint and those looking to upgrade the Sun 64-bit hardware. We areaggressively working on a large process which is expected to begin this month.The program includes Microsoft's long standing support from Microsoft and forthe Microsoft's [Sun] and for a comparable Sun relationship.

We will go to Bull. Back in thespring we announced the signing of an OEM agreement with Bull that will enableBull to market and sell Bull branded versions of CommVault's full SimpanaSoftware Suite through its channels worldwide. Bull is taking a very structuredapproach and investing in the necessary resources to make these productssuccessful in the market. The Bull funnel is developing well and we areconfident Bull will meet our FY '09 goals for revenue generated by Bull.

Arrow, as you know about a yearago we signed a wide ranging distribution agreement with Arrow helping ourNorth American commercial markets. In July 2007, we amended our agreement withArrow to include our U.S. Federal government market. Many of our North Americanresellers have been transitioned to Arrow throughout fiscal 2007 and fiscal 2008.Wegenerated approximately 11% of our total revenue through Arrow in the ninemonths ended December 31, 2007.

Let's talk about SaaS, we see Software-as-a-Serviceas an area for a strong growth potential and will continue to invest in both technologyand distribution in this space. You may have seen a recently announced ROMS servicewhich we believe is the most sophisticated subscription based automated supportservice in the industry and this was launched in our current quarter. Inaddition, we have established a good foundation with many customers using our softwareto deliver SaaS dated management solutions.

Two of our largest customers inthis space are Incentra and Rackspace and we have been delighted with thesuccess we have had with both of these companies. Several weeks ago weannounced that we expanded our relationship with Incentra Solutions for SaaSofferings in North America and Europeannouncing a three -year extension to our existing agreement. Incentra has beenusing CommVault as the foundation for the company's SaaS offerings over thepast five years.

Let's talk a little bit about CommVault'scurrent position, our market's buying pattern for our solutions continues toremain robust. While we are not naive to the current economic climate, we havenot seen a slowdown. We believe we have strengthened our foundation for growthgoing into FY '09. All the key elements are in place for us to execute andachieve our FY '09 objective. This includes [want] a strong product line. Wehave established momentum in the market with Simpana 7.0 which hassignificantly strengthened our competitive position in the market. New productsare contributing to growth. We have been successful in broadening the company'sproduct offerings beyond traditional backup. We move into FY '09 with a solidmomentum and our emerging product lines. We have streamed distributionglobally.

International expansion is amajor contributor to growth. We have strong sales and systems engineering teamsin all of our key markets. We have successfully added three tier distribution.We are getting solid distribution leverage internationally from our existingstrategic distribution partners Dell and HDS. We have added two new strategicpartners in Bull and Sun. We have established positions in many newinternational markets such as China,Singapore, Latin America, South Africa and the Middle East among others.

We have best-in-class support. Wehave distanced ourselves from our competition in regard to support. We aredriving further strengthen in our support position with the launch of our firstautomated support service offering ROMS. We have a clear divine vision. Webelieve our relative competitive position has improved. We believe we havegotten stronger and our major competition is not moving as fast as we are. Wehave a well-defined vision going forward, and are making good progress onbringing technology and products to markets beyond Simpana 7.0.

At the present time we see strongdemand across all vertical sectors of the market and across all geographies. Weare well aware that the current economic climate has added a lot of uncertaintyabout future demand. We know that tech spending usually lags in economicdownturn and we will continue to watch the situation closely.

Given the strength of our currentposition, confidence in our vision, and many opportunities to investor growth,we think it is prudent to increase our near-term spending in sales andmarketing more than previously planned in order to maximize the long-termshareholder value. Specifically, we will be relatively more aggressive in thenear-term in hiring sales representatives particularly in the United States where we have fallenbehind our recruiting goals.

We are doing this with theknowledge of the risks associated with the current economic climate. As you mayhave seen we started to advertise again in key industry publications, as wejust recently launched our Switch campaigns which you can also see on ourwebsite. Other than the Simpana launch this past summer, we have nothistorically spent money on advertising. As we go after bigger enterprise dealswe have found that we need to spend more on our sales and marketing initiativesthan previously thought.

The market's reaction to Simpanahas exceeded our expectations. This acceptance of Simpana has reinforced ourdecision to continue to focus on investing for long-term growth. We believe weare in a very good position to continue to take market share and we want to makethe necessary investments to ensure that, that happens. We will continue toaggressively invest in sales and distribution in order to meet our FY '09revenue and growth objectives. In addition, we will continue to invest stronglyin our R&D as we develop our next generation portfolio of products.

Our operating margin growth maybeslightly impacted in the short-to-medium term as a result of our more aggressiveinvestment and hiring strategy, but we believe now is the time to put addedemphasis on growth. This will enable us to continue to build our infrastructurein preparation for significant future product releases.

After Lou's comments I will speakbriefly about our new ROM service and about the future product direction of thecompany. I will now turn the call over to Lou who will provide more detailsabout our quarter results as well as our FY 2008 guidance. Lou?

Lou Miceli

Thanks, Bob and good afternooneveryone. As Michael mentioned I will be referring to mostly non-GAAP numbers.A full reconciliation of GAAP to non-GAAP results can be found on Table IV toour press release.

Let me begin with the review ofrevenues. Total revenues increased 31% year-over-year and 6% sequentially overthe prior quarter. Software revenues increased 28% year-over-year and 2%sequentially. Approximately two-thirds of our software revenue continues tocome from our installed base with the rest from new customers.

Services revenue increased 36%year-over-year and 12% sequentially. The higher services revenue growth was favorablyimpacted by higher utilization of professional services due in part toincreased implementation of Simpana 7.0. The rate of maintenance renewalscontinues to be very high on a worldwide basis largely due to the company'sreputation of outstanding support and consequently we continue to see growthopportunities in services revenue.

The revenue mix for the quarterwas 54% software and 46% services, which is a slight shift from 55% and 45% forthe prior year period. The overall growth in software revenue was driven bythree primary factors, a higher volume of purchases from both new and existingcustomers, significant growth in our international operations, and a highervolume of sales greater than a $100,000. Specifically for the nine months ended12/31/07, thegrowth in software in foreign locations was 73% and in the U.S. it was 11%.

In addition, the number ofsoftware transactions greater than a $100,000 was up by 38% over the prior yearwith a significant amount of transactions over a $100,000 occurring in the U.S.Software revenue generated through indirect distribution channels wasapproximately 80% for the nine months ended 12/31/07 and approximately 70% forthe prior year period. The increase in software generated through indirectchannels is a result of both an increase in software revenue from internationaloperations and a shift to indirect distribution channels in the U.S.The shift to indirect distribution channels in the U.S. is sometimes driven bycustomer purchasing preferences, which may cause this static to fluctuate fromtime-to-time without any significance.

We will continue to investheavily in both direct and indirect channels. However, we anticipate that theamount of revenue generated through indirect distribution over the long-termwill continue to be significant and this will require highly skilled combo ofsales and field engineer teams working with our indirect partners for thelarger enterprise transactions.

Now on the gross margins. For thequarter gross margins were 86.3%, which is up 85.4% in Q3 fiscal year 2007.Gross margin for services revenue was 73.1% in the current quarter versus 70.5%in the comparable prior year period, due to a stronger mix of maintenancecontracts and lower professional services. Gross margins on our softwarerevenue were 97.6% in the current quarter versus 97.5% in the prior yearquarter.

Total operating expenses for thequarter were $34 million. Sales and marketing expenses increased $5.6 millionor 34% over the prior year quarter. Approximately 75% of this increase wasrelated to employee compensation, which includes higher headcount costs, aswell ad higher commissions on record revenues.

The rest of the increase can beattributed to higher travel and related expenses, additional advertising, andslightly higher rent associated with geographic expansion. This increase isconsistent with our plans to strengthen our position in the market and positionus for growth in fiscal year 2009.

R&D spending increased byabout $800,000 in the quarter or 14% over the prior year period. The increasewas primarily due to higher employee compensation associated with increasedheadcount. We continue to leverage our investments in R&D by expanding our Hyderabad, Indialocation. We now have 90 employees in India with the majority of thesebeing in R&D. Our Simpana 7.0 product significantly expands and builds onour previous QiNetix platform. We believe we are creating competitivedifferentiation in the marketplace. We anticipate that our investments in R&Dwill produce future products that will keep us competitive and as a result weexpect to continue to invest heavily in R&D.

G&A expenses increased by$1.3 million in the quarter, which was 32% over the prior year period. Thisincrease is primarily a result of higher head count needed to support theexpansion of operations on a worldwide basis as well as an increase forinternational tax planning fees. Our total worldwide headcount increased by 43people, from 790 at the end of September, to 833 at the end of December. Theheadcount increases were primarily in sales and marketing, technical services,customer support and R&D.

Non-GAAP operating margins were17.1% for the quarter, resulting in non-GAAP operating income of $8.6 million.This represents EBIT growth of approximately 51% year-over-year. The non-GAAPnet income was $6.9 million and non-GAAP EPS was $0.15 per share based on adiluted weighted average share count of approximately 46.1 million shares.

Now moving to the balance sheetand cash flow statement. As of December 31st, our cash balance was $95.1million, up approximately 20% from $79.2 million as of September 30th. Cashflow from operations was approximately $13.1 million in the current quartercompared to $8.7 million in the comparable prior year quarter. Free cash flow whichwe define as cash flow from operations less capital expenditures came in at$11.9 million for the current quarter compared to $7.8 million in thecomparable prior year quarter. Cash flow from operations was strong due to positivechanges in working capital.

Our DSO was 60 days which ishigher than historic averages. This is up from 55 days in the prior quarter andis a result of several factors. Higher accounts receivable balances caused by ahigher percentage of indirect revenue, higher maintenance support billings inthe quarter, increased international revenues, and also more deals over $100,000.

Enterprise deals typically closed later inthe quarter thereby resulting in higher DSOs. Deferred revenue increased $4.3million or approximately 9% sequentially over the prior quarter. Deferredrevenue is comprised of mostly 12 months maintenance contracts and professionalservices. This increase is an indication of our strong services business andincreased software sales from our growing installed base of approximately 7,500customers.

Capital spending wasapproximately $1.2 million in the third quarter. Our current estimate forfiscal year 2008 remains between $4.2 million and $4.4 million.

Now onto taxes, you'll note thatfor the quarter we recognized a GAAP benefit of approximately $900,000 on thetax line. This benefit is primarily the result of a $2.4 million reversal of adeferred income tax valuation allowance that we maintained in certaininternational jurisdictions.

This one-time GAAP adjustment hasbeen included as a pro forma adjustment on Table IV of our press release.Excluding the impact of this one benefit, we estimate that our fiscal 2008 GAAPtax rate will be in the range of approximately 31% to 33%.

Currently, we continue toimplement tax planning measures that are expected to reduce the long-termterminal rate to within a range of 28% to 32% over the next few years. For thequarter, our non-GAAP income and EPS contains a pro forma effective tax rate of28%, which we will maintain for the remainder of fiscal 2008 on a non-GAAPbasis.

Our estimate of the actual cashtax rate for fiscal year 2008 is approximately 10% based on currentassumptions. This is mostly for state taxes, federal alternative minimum taxes,and for taxes in locations around the world where we have used up all of ourNOLs.

In the United States, we believe we havesufficient net operating losses and tax credits to offset taxable income forthe next two fiscal years. Consequently our cash tax rate should continue to besubstantially lower than both the GAAP and non-GAAP tax rates. Over the nexttwo years our cash tax rate will approach our GAAP tax rate.

Now moving on to fiscal year 2008guidance. For the 12 months ended March 31, 2008 revenue is expected to be in the range of a$195 million to $196 million. Using the mid-point of our guidance thisrepresents revenue growth of 29.4% year-over-year. We are expecting fiscal year2008 non-GAAP gross margins to be between 86% and 86.3%.

As Bob, mentioned earlier becauseof the validated market acceptance of Simpana 7.0, strong growth in emergingproducts, as well as solid acceptance of our products internationally, we areincreasing our near-term spending in sales and marketing beyond previously plannedlevels in order to maximize long-term shareholder value. We will investaggressively in sales and marketing in order to meet our fiscal year 2008 andfiscal year 2009 revenue objectives. We still believe that we can incrementallyincrease our operating margins as we grow the top line. However we arereinvesting more aggressively in order to strengthen our position for long-termgrowth and increase our market share in both our core and emerging products.

We are now expecting non-GAAPoperating margins to be between 16.7% and 17%. Using the mid-point of ourguidance, this represents EBIT growth of approximately 45% year-over-year. Ourlong-term operating margin goal continues to be in the low-to-mid 20s. We arelowering our non-GAAP diluted earnings per share, which is now expected to bein the range of $0.56 to $0.58 per share using a projected fully diluted sharecount of approximately 45.5 million to 46 million shares and applying a proforma tax rate of 28% for the full year. The non-GAAP EPS guidance excludesapproximately $0.12 to $0.14 per share related to the effects of stock-basedcompensation expense under FAS 123R, which is net of non-GAAP income taxexpense of approximately $0.05 per share. We will provide our fiscal year 2009guidance on our next call, which we anticipate will occur in mid-May due to ourMarch 31 fiscal year end.

That concludes my prepared remarks. Let meturn the call back over to Bob. Bob?

Bob Hammer

Thank you, Lou. I would like tospend a few minutes on a brief summary of our newly announced ROM service and abroader perspective of our future product direction. ROMS, which we believe isthe most sophisticated subscription based automated support service in theindustry, was launched in our current quarter. This new service, which has beentwo years in the making, provides our customers with an automated interfacethat gives them a real time view of their storage and data environment andenables real time identification of problems, their root cause, and cures. ROMSoffers comprehensive on demand reporting and monitoring capabilities for datamanagement, access, and protection technologies.

Through a user friendly intuitiveweb dashboard, our customers can access and track real time alert trend andstorage usage reports anytime, anywhere. ROMS integration will enable customersto dramatically reduce both operational cost and system downtime. ROMS enablesreduction of personnel expenses associated with data management activities byallowing customers to offload their responsibility to CommVault's ROMS systemspersonnel. We expect that time to resolution for issues effecting managementsystem will be greatly reduced as ROMS provides CommVault's support with allthe necessary information to address alerts as they occur.

We believe that Simpana 7.0 andROMS enable the best value proposition to the customers in this industry. Iwill just want to take a minute about future direction. I will talk more aboutthis as time goes on. This is beyond Simpana 7.0.

Going forward, we have focusedour product development efforts on areas that we believe will providesignificant additional high value add to our customers. These includeinnovative new ways to manage data protection, innovations in singleinstancing, and de-duplication, next generated automated records management,better ways to manage workstations and laptops, better ways to mange the growthof databases, and enhance data management capabilities in virtualizedenvironments. We are confident we can add value in each of the areas mentionedand believe our future developments will help ensure that we remain the leadinginnovator in broad base data and information management software technologiesand services.

We are very confident about ourfuture and our ability to create long-term shareholder value. We are generatinga significant amount of cash and had approximately $95 million of cash on handon our balance sheet as of December 31, 2007. We feel the best use for a portion of our cash is to buy backsome of our outstanding stock. That is why our Board of Directors has justapproved a repurchase program authorizing the company to repurchase up to 40million of common stock over the next 12 months. We will be opportunistic withthe buy back subject to market conditions and will keep you informed of ourprogress each quarter.

Finally, I would like to announcethat Al Bunte has been appointed to our Board of Directors at the meeting lastweek. Al has served as our Executive Vice President and Chief Operating Officersince October 2003, and served as our Senior Vice President from December 1999until October 2003. During his tenure with CommVault, Al has providedoutstanding senior management leadership in many areas of the company includingstrategy, product development, marketing and support. He has been particularlyeffective in ensuring that the company is consistently innovative and hisappointment to the Board is well deserved.

And with that, I like to turn thecall back to Michael, who will open it up for Q&A. Thank you.

Michael Picariello

Thanks Bob. Before we open up thelines for your questions, I would like to highlight a few upcoming InvestorRelation events. Al, will be speaking at the Goldman Sachs TechnologyInvestment Symposium in Las Vegason February 26, 2008.And either Bob or Al will present at the Small Mid Cap Mini Conferencesponsored by Wachovia in Park City, Utah on March 13, 14, 2008. BothBob and Al's respective presentations at each conference will be available liveon our investor relations website and will also be archived for 90 days.

Please open up the call forquestions.

Question-and-Answer Session

Operator

Thank you very much, sir.(Operator Instructions). We will take our first question from the line of TomCurlin of RBC. Please proceed.

Tom Curlin - RBC

Hey, good afternoon, andcongratulations on another strong quarter.

Bob Hammer

Thanks, Tom.

Lou Miceli

Thanks, Tom.

Tom Curlin - RBC

You have not provided anyguidance yet for fiscal '09, that's correct, right?

Lou Miceli

That's correct, Tom.

Tom Curlin - RBC

Just given the comments oninvestments, should we assume that -- how do we think about the trajectory ofoperating expenses relative to revenue? For fiscal '09, I realize you may notbe willing to provide specifics, but there is definitely language in yourprepared comments that would suggest those growth rates are perhaps convergingor at least will be closer to each other than they were in '08. So how shouldwe think about the trend? Do you think OpEx will grow roughly as fast asrevenue in '09?

Bob Hammer

Well, the issue we are facing,Tom, which is a kind of a -- it's a positive issue in that as I mentioned inthe call, the Simpana acceptance in the market has been -- has exceeded expectationsalmost across the board. So we are really confident about [primarily] on corebut in our emerging products -- and this is global. So we are confident aboutthat. Our distribution network is as strong as it has ever been in the sensethat not only our channel partners but our CommVault teams globally have allbeen upgraded to sell high-end solution cells. So we have got a really strongfoundation there. And the basic fundamental demand appears to us globally to bevery strong. So given that, we feel very prudent to increase spending andemphasize a little bit more on the growth side than optimizing our operatingincome. It doesn’t mean we will see operating income accretion because weprobably will, but we’re working through that right now. So we just see moreopportunity than we thought, and we think it prudent and we kind of re-look atthe strategy and take advantage for the growth opportunity in front of us alittle bit more than we recently had anticipated.

Tom Curlin - RBC

And when you say operating-incomeaccretion, you’re speaking on a percentage-margin basis?

Lou Miceli

Yes, on a percentage marginbasis.

Tom Curlin - RBC

So, it’s I guess, possible to I guess a possible scenariowould be that operating margin for fiscal ’09 would be similar to fiscal’08?

Bob Hammer

That would be at this time, anddon’t hold to me this but that -- we’ve not given any guidance there, but thatshould be the worst case in terms of what we’re going suggest but we haven’tlocked it down.

Tom Curlin - RBC

Okay, and then just oncompetition in the quarter. Symantec has a new version of net backup out. Haveyou seen any unusual behavior from them on the pricing front or bundlingtactics, just what’s the latest I guess specifics on?

Bob Hammer

Well, in general we continue toincreasingly take share from Symantec, and we haven’t seen any let up in ourability to beat them either in the major accounts for the mid-market. We justhaven’t seen any material change that we could see yet -- doesn't mean we won't-- but we haven’t seen that. In regards to pricing clearly, when they see usand our major account that they think is strategic, they will get extremelyaggressive meaning they will take software to down to zero. We’ve seen that;we’ve seen them take software down to zero and to discount maintenance to keepus getting an account. And some of the accounts we won anyway. But they willget that -- what I call paranoidcallyaggressive when we -- they see us coming in their strategic areas.

Tom Curlin - RBC

And are you seeing more of that,just because that's a major change, even for an existing net backup customerright to do that upgrade. So I would imagine there is -- there are more dealswhere things have opened up, right?

Bob Hammer

There are more deals when thingshave opened up, that is correct.

Tom Curlin - RBC

I mean, Bob, with that are yousaying then I guess even more aggressive or a greater mix of deals where theyare very aggressive in your pipeline?

Bob Hammer

Well, in the past we used to seethem drop software prices down 75% or 50%. This is the first time we're seeinga few deals where they have actually dropped it to zero.

Tom Curlin - RBC

Okay. And then finally on the Sunagreement, can you elaborate a bit on the nature of the product, how you invariablypackaged through that channel from a product perspective and then just from ago-to market how you view at-large enterprise versus mid-enterprise, how doesthe go to market look?

Bob Hammer

So, let me comment on it at the$100,000 foot level. Clearly, when Sun decided to bring and decided to supportMicrosoft's 64-bit architecture and operating system, they were looking toprovide -- they did a management capability along with that both from theserver and storage side. If you read their press releases, they made statementslike "it's not all about historic it's all about the data," which wassimilar to our perspective on the market. So both Sun and Microsoft, given thatperspective, were looking for a best-in-class partner here, and both Sun andwith Microsoft's strong support suggested that, that partnership be consummatedwith CommVault. And clearly this announcement was focused on some key areas,and those were Exchange and SharePoint. Now you know, Tom, Sun covers both theenterprise and SMB markets. So it's too early to tell where we are going to seethe traction, but I think they have trained a lot of their people on it. Itwill launch in mid-February. And as we go a little bit further down the road,maybe we can give you a bit more color as to where we are seeing the tractionon it. But I think all three companies are quite optimistic that this is goingto be quite successful.

Tom Curlin - RBC

Okay, thank you very much.

Bob Hammer

Thanks, Tom.

Operator

Thank you very much, sir. (OperatorInstructions). Our next question comes from the line of Derek Bingham ofGoldman Sachs. Please proceed.

Fred Reid - Goldman Sachs

Hi, guys. This is [Fred Reid] forDerek.

Bob Hammer

Hi, Fred.

Fred Reid - Goldman Sachs

Hi, are there any verticals whereyou are seeing a particular strength or weakness perhaps like financialservices or government?

Bob Hammer

We are seeing very strongstrength in government globally and, surprisingly enough, our strength in thefinancial services market relative to where we have been has been strong.Across the board within the United States, we have not seen any drop in demandin the financial sector from our customer base yet.

Fred Reid - Goldman Sachs

Great. And one follow-up, theSimpana upgrade cycle, can you quantify how that's impacting ASPs or deal sizesat all?

Bob Hammer

There is a stat in our Q, and itis impacting more the number of deals we getting over $100,000. And I justmentioned in my summary that in deals over $100,000 that 33% of the revenue inthose deals is coming from product sales and backup. If you look at ASP, it isa meaningful because it's a bit of a large number of accounts they don't see itbut so we don't look at that stat, but we just see from our Q that in dealsover $100,000 the average ASP there is $200,000.

Fred Reid - Goldman Sachs

All right, great thanks a lot.

Operator

Thank you very much sir, andladies and gentleman, our next question comes from the line of Aaron Schwartz ofJP Morgan. Please proceed.

Aaron Schwartz - JP Morgan

Good afternoon. Last quarter, youhad mentioned that you had seen little leverage from the OEMs in the quarterbecause there was still on boarding with Simpana. I was just wondering, couldyou provide an update on that and then two -- did that have an impact in thequarter? I know Dell can be sort of up and down, and maybe last quarter it wasnormally on the up side, but it did look because it may be little lower thanexpectations this quarter.

Bob Hammer

Well, Dell has got a staggeredquarter, so that Aaron you won't Dell impact until full Q4. Right?

Aaron Schwartz - JP Morgan

Okay.

Bob Hammer

Because most of Dell revenue lastquarter didn't include the upgrade. So the first impact you'll see from Dell isgoing to be in the March quarter.

Aaron Schwartz - JP Morgan

So, you would expect that to bestronger than the March quarter relative to the quarter you just printed?

Bob Hammer

You'll certainly see a lot moreSimpana 7.0 from Dell in the March quarter than in the December quarter.

Aaron Schwartz - JP Morgan

Okay, because I am just trying toreconcile from your comments. It sounded like you are pleased with the largedeal upon you gained a lot of the metrics around the larger on transactions,and it seems like Dell was more of the volume-based deals, and just given theseasonality of December and where you are at in the product cycle, I think someexpectations were for a little better license growth in the quarter. I'm justwondering it may be the volume business and Dell has been pushed out a quarteror just sort of trying to reconcile all those comments?

Bob Hammer

No, the issue, and I've saidthis, and in case you didn't catch it between the lines, I'll say it a littlebit more clearly. If you look,our international revenues were up substantiallyright, 86% year-on-year, and that's because we invested heavily, and it's beenon the street internationally. And then invested just as heavily domestically,we're going to kind of turn that around here in the new term. So that is morerelevant to top-line growth than any other stats that you got.

Aaron Schwartz - JP Morgan

Okay.

Bob Hammer

We got the product, and we gotthe demand. We're doing well versus competition, et cetera. It really comesdown to this whole investment strategy of ours, and we're addressing that,trying to be more effective and more consistent about it.

Aaron Schwartz - JP Morgan

Okay. So it seems like you arestill optimistic about the pipeline, so you're just trying to invest more tomay be feed better execution in terms of the pipeline to dollars?

Bob Hammer

Well, that is exactly correct.

Aaron Schwartz - JP Morgan

Okay. And then just a follow-upon all the subscription-based announcements you had in the quarter and some ofyour comments: How do you actually envision that impacting the model longerterm in terms of what will be maybe higher deferral rates around product salesfor that?

Bob Hammer

That's a good question. I mean,we're seeing it now. We are -- it's a subscription-based model, but the revenuefrom those deals is recognized in the current quarter. In other words, overtime those subscriptions build up, and they get recognized on a quarterlybasis. So it's not that deferred is growing, it's just that oursubscription-based revenue as a percent of total licensed revenue is growing.It is not going to defer.

Aaron Schwartz - JP Morgan

Okay, and then lastly: thequestion I had is in terms of your partnership with Microsoft, I know it hasbeen an active partnership, but nothing had been formal. With the acquisitionof (inaudible), did that change anything there in terms of potential workingtitle with Microsoft?

Bob Hammer

Well, its got the potential to dothat. Yes.

Aaron Schwartz - JP Morgan

Okay. Well thanks for taking myquestions.

Bob Hammer

Welcome.

Operator

Thank you very much, sir. Ladiesand gentlemen, your next question comes from the line of Brent Bracelin ofPacific Crest Securities. Please proceed.

Brent Bracelin - Pacific Crest Securities

Thank you. Bob, my first questionconcerns the demand environment. Could you just compare-contrast your kind oforder pipeline today versus kind of three months ago going into last quarter?

Bob Hammer

Going into the December quarteror going into the March quarter?

Brent Bracelin - Pacific Crest Securities

Compared today versus threemonths ago?

Bob Hammer

It's significantly higher.

Brent Bracelin - Pacific Crest Securities

Okay, follow up to that: Would beas you look at the large deal,s you did see a kind of a slight down tickarguably from that nearly high level last quarter? Did you see any sort oflarge deals slip out of December? Large deals are always tough to predict whenthey close. But could you comment a little bit on kind of your visibility inthose large deal kind of pipeline?

Bob Hammer

Well, we certainly had visibilityto more large deals than we closed.

Brent Bracelin - Pacific Crest Securities

Okay.

Bob Hammer

So the answer is yes, but we sawsome -- but for any other, there is no trend reason. It is just we did see someof that.

Brent Bracelin - Pacific Crest Securities

Okay, and then another follow-uphere for me is: You look at kind of the timing around kind of making someaccelerated investments in marketing and sales. Today, clearly, you saw 2.02 25 internationally.How do you know the slowdown in the U.S. isn't kind of economic-drivenversus kind of a sales-marketing issue?

Bob Hammer

Because we look at sale-forceproductivity, and the numbers for sale-force productivity were right on-targetlast quarter. It was just numbers. In other words, we weren't seeing budgetcuts or anything else, and your sales productivity that was going to tally-upwith pretty much with what was going on. We slice that in a number of differentways. We got, really got hand on that.

Brent Bracelin - Pacific Crest Securities

Perfect, thank you.

Operator

Thank you very much, sir.(Operator Instructions) Our next question comes from line of Aaron Rakers of WachoviaSecurities. Please proceed.

Aaron Rakers - Wachovia Securities

Yeah, thanks guys. A couple ofquestions from myself as well. I guess the first one I want to go back to thecomment about behind the goals in terms of recruiting for the company. Can youwrap some color around that, specifically as it references to the sales force?What's your target in terms of sales force additions and then kind of segwaythat into what you typically see in terms of productivity ramps from new hiresin that sales force?

Bob Hammer

Well, we don’t give out thosenumbers, Aaron, but clearly we wanted to be further ahead in the U.S. than wewere on recruiting side. And there is couple of factors. There are lots ofreasons, no excuses for that, but we had this massive product launch, and inaddition to that is part of that product launch in several regions globally anddomestically. We did some fairly significant retooling to prepare those areasto sell a much broader enterprise suite. So, we are extremely successful on theretooling side. We are exactly where we want to be and from a number standpointdomestically. We didn't hit the target we wanted, and we just have a lot morefocus on it and trying to get in terms of our internal processes to deliverthat in an effective way. We're spending some extra time and attention there.

Aaron Rakers - Wachovia Securities

And in terms of productivity asyou look to incrementally add more people. How do we think about the preferredramp-up new hires coming on?

Bob Hammer

I'll let Al answer that becausehe deals and we review that really in-depth detail every 30 days, and Al's runsSaaS model. So he can answer that for you.

Al Bunte

Aaron, it's as Bob says. We lookat and slice it in a number of different ways. So it makes a big differencebetween a guy going into an existing what we call existing territory versus abrand new territory or even a country. But in general when you average that allout its two to three quarters for a sales team to get up to speed from minimalproductivity to our full levels of productivity.

Aaron Rakers - Wachovia Securities

Okay. And then the secondquestion or topic would be, you talked about Symantec becoming it sounds likeincrementally more competitive in the market. Can you talk about others outthere in the market namely EMC, is that the low hanging fruit for you, is therebeen any change on the competitive landscape on that front?

Bob Hammer

We don't see EMC very much, wesee Avamar on occasions. But in a big enterprise data management informationmanagement DOE we don’t see them as a significant competitor it's mainlySymantec.

Al Bunte

Or IBM.

Aaron Schwartz - JP Morgan

Okay. And when do you expect, Inow you mentioned the launch of Sun in the mid-February timeframe, clearlythere is a training cycle that has to take place. Is it more of a second-half'08 when we start to see a revenue contribution or is it even in calendar 2009when we think you start to see some material revenue from the Sun relationship?

Bob Hammer

I can tell you from the planningpoint of view it'll be later in 2008. But we could see it -- we could getsurprised here it could be significantly better. But typically CommVaultwhether it's a new product a new relationship, we don't forecast a lot of majorup tick early until we can validate it. So, it is quite conservative there, butI think that the relationship has got a lot of potential.

Aaron Schwartz - JP Morgan

And then final thing for me, lastquarter you gave a little bit of flavor around what you are seeing in terms ofthe installed base upgrading to the Simpana 7.0 platform, an update on thatfront, where that currently stands and when you expect to see may be that hitthe 80% plus mark? It would be helpful.

Bob Hammer

I stretched that one a littlebit, Aaron. But clearly, ourinstalled not what's been purchased but our installs off Simpana 7.0 are nowwell north of a 1000 installs. So, we are really confident about wherethis product is and its ability to produce the desired results. So, the majorconstraint about how many are still there is really tied to our servicesorganizations' ability to upgrade people fast enough. So, we are as happy aboutthat as we can be. And these upgrades have gone exceptionally well. So, we arereally happy about all that. The quality level of 7.0 is the best, from ourinternal stats, the best release we ever had and it was our largest release.So, we are very happy about that as well.

Aaron Schwartz - JP Morgan

And final thing for me, youmentioned earlier. I will take a stab at this. Your pipeline sounds like itspretty healthy going into the quarter. When you compare that relative to yoursequential revenue growth, have you seen your pipeline grow substantially morethan your sequential revenue growth? Any kind of flavor you can give on thatfront and I will end there? Thanks.

Bob Hammer

On a relative basis -- relativeto our expected result, our pipeline in the March quarter is higher than in theDecember quarter.

Aaron Schwartz - JP Morgan

Fair enough. Thank you.

Operator

Ladies and gentlemen your nextquestion comes from the line of Tim Klasell of Thomas Weisel Partners. Pleaseproceed.

Marks Griffin- Thomas Weisel Partners

Hi, how are you doing? It's MarksGriffin stepping in for Tim.

Bob Hammer

Hi, Mark. How are you?

Marks Griffin- Thomas Weisel Partners

Good, how are you guys doing?

Bob Hammer

Good.

Marks Griffin- Thomas Weisel Partners

Not to beat a dead horse, butjust one question on the increased S&M. Have you started the hiringalready, or like have we come to some kind of a percentage or we’ve got a thirdof the guys already on the books or something like that?

Bob Hammer

We’ve definitely started.

Marks Griffin- Thomas Weisel Partners

Definitely started in the?

Bob Hammer

But, we still have a fair way togo, but we’ve definitely started.

Marks Griffin- Thomas Weisel Partners

Okay, alright that kind of[killed]. Can you enlighten us a little bit more on the Hitachi relationship? You kind breezedthrough that one. You kind of just said it was going well, and then I was justwondering if you can give.

Bob Hammer

Well, I mean the numbers isyear-over-year in the percentage are up substantially.

Marks Griffin- Thomas Weisel Partners

So it's up.

Lou Miceli

It is still very choppy, meaningthere is certain areas which has been consistent with what I've said in thepast. There are certain international areas that are going really well, we'vewon a large number of large deals and there are some very large deals in thepipeline going forward with Hitachi.But its not a, what I'd say, a global, well-oiled machine like Dell at thispoint.

Marks Griffin- Thomas Weisel Partners

Okay. It sounds good. That’s itfor me. I appreciate it.

Bob Hammer

Okay.

Operator

And ladies and gentlemen our nextquestion will come from the line of Phil Winslow with Credit Suisse Pleaseproceed.

Dennis Simpson - Credit Suisse

Yeah, this is Dennis Simpson forPhil. Just a real quick on the supply line, can you talk about which modulesthat are showing the more strength?

Bob Hammer

Yeah, I think we said in thecall, if I pick them up pick.They were single instancing, archiving, there is a very large dataclassification and search -- they are the major ones.

Dennis Simpson - Credit Suisse

Okay, thanks.

Operator

Ladies and gentlemen, your nextquestion comes from the line of Dan Renouard of Robert W. Baird. Pleaseproceed.

Dan Renouard - Robert W.Baird

Hi. Thanks. Most of my questionshave been answered. But can you guys talk about the hiring environment, hasthat changed at all? And are most of your hire is coming from competitors, orare you guys typically training on your own? Maybe you could just enlighten usa little bit on that front? Thanks.

Bob Hammer

Yeah, Dan, what we've found isthat we need a special skill set and a special set of experience to succeedwith the breadth and the depth of our software suite, particularly as we focuson the enterprise, which requires really sophisticated solution side. And so,we are very selective in the process. And the environment right now I'd sayseems to be a little bit easier internationally than it is domestically. But ifI had to put a trend on it, it's probably getting a little easier than harder,where maybe a year ago it was probably harder versus easier.

Dan Renouard - Robert W.Baird

Thank you.

Operator

Ladies and gentlemen, your nextquestion comes from the line of Steve Koenig of KeyBanc Capital Markets. Pleaseproceed.

Steve Koenig - KeyBanc Capital Markets

Hi guys. Thanks for taking thequestion.

Bob Hammer

Hi, Steve.

Steve Koenig - KeyBanc Capital Markets

Just wondering about, kind of alittle color on the composition of revenue growth going forward here, yoursources revenue accelerated nicely as you utilized some of the new hires thatyou made in the first half in consulting. Should we expect, as we get throughQ4 here and in the next year, that consulting is going to continue to sustain. It's kind utilizations,and the mix should shift a little bit more like towards consulting. And thentherefore on the software revenue line you have been flirting with 30% growththere. But should we count on that 30% coming in to (inaudible) or should themix kind of be where it was this quarter?

Bob Hammer

Well, this quarter -- what I saidlast quarter was that in the September quarter we were down sequentially inservices, mainly because we had taken a lot of our field engineering force, andthey were focused on training for Simpana 7.0. So, we lost lot of utilization.We expected that it will come back strongly in the December quarter, and itdid. So, you saw a spike up, as a result of that.

We are not giving guidance onthis, Steve. But going forward if you look at the fundamental strength of thecompany, the services and license revenue should be pretty much in syncovertime and unless we step that up like with things like (inaudible) so youmay get some increased leverage. But fundamentally, if you look at where isthat growth coming from. If we have accelerated growth, clearly if you can workwith the numbers in products other than back up and recovery. There is noreason given where we are in back up and recovery that we shouldn’t seereasonably strong growth there.

And we have strong growthinternationally, on top of all that. And we are adding distribution. So, thefundamental price for us is to sustain our good solid growth rate, both inservices and in license revenue, we just have to translate that to guidance andwe will always be prudent in our guidance.

Steve Koenig - KeyBanc Capital Markets

And so, is it reasonable for usto expect that given the lag time between hiring and making reps productive --any acceleration, there or would it be more around the second half and therelease of product functionality?

Bob Hammer

We don’t need additional productsto drive growth.

Steve Koenig - KeyBanc Capital Markets

Okay.

Bob Hammer

Additional functionality reallywill impact FY10. We have sufficient products in our pipeline to sustain; buildgrowth for FY09.

Steve Koenig - KeyBanc Capital Markets

Okay. But it’s reasonable for usto think it’ll take a couple of quarters to make the reps productive?

Bob Hammer

Yes, the new reps that we bringin will take a couple of quarters to get productive.

Steve Koenig - KeyBanc Capital Markets

Okay. Thanks a lot.

Operator

(Operator Instructions)

This time, we have no furtherquestions in queue. We like to thank you very much for your participation intoday’s conference call. This concludes your conference for today and you maynow disconnect. Have a good day. Thank you.

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Source: CommVault Systems F3Q08 (Qtr End 12/31/07) Earnings Call Transcript
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