Guidance Software Inc. Q4 2007 Earnings Call Transcript

Guidance Software Inc. (GUID)

Q4 2007 Earnings Call

February 28, 2008 5:00 pm ET

Executives

Bill Powell - Director of IR

Victor Limongelli - President and CEO

Frank Sansone - CFO

Analysts

Philip Rueppel - Wachovia Securities

Matt Bugarin - Raymond James

Kevin Buttigieg - Stanford Group

Mark Schappel - Benchmark

Jonathan Ruykhaver - ThinkEquity Partners

Josh Jabs - Roth Capital

Israel Hernandez - Lehman Brothers

Presentation

Operator

Good day and welcome to the Guidance Software fourth quarter earnings results conference call. (Operator Instructions)

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

Bill Powell

Thank you. Good afternoon and welcome. Thank you for joining us on Guidance Software's fourth quarter and yearend 2007 earnings conference call. As your host for our call this afternoon, I have the pleasure of introducing Victor Limongelli, President and Chief Executive Officer of Guidance Software; and Frank Sansone, Chief Financial Officer of Guidance Software, to present and discuss with you our financial performance and other operating metrics.

Before Victor and Frank begin, I have a few administrative notes I would like to go through for the benefit of our audience. Guidance Software reports its results on a Generally Accepted Accounting Principles or GAAP basis in conformity with Security and Exchange Commission standards. These results may differ from results published by analyst or the media featuring pro forma financial results which may not be in conformity with regulatory standards. We encourage everyone to review our financial results presented on a GAAP basis, which are detailed in our press release issued today at 4:01 PM Eastern Time.

Some of the information discussed on this call including projections regarding revenue and operating results, may contain forward looking statements. These statements involve risks and uncertainties that may cause actual results to differ materially from those set forth in the statements. Additional information concerning these risks and uncertainties can be found in the Company's most recent periodic reports filed with the US Securities and Exchange Commission. Guidance Software assumes no obligation to update any forward-looking statements.

Let me describe the format for today's call. Victor will begin the call with some highlights; a brief overview of the year and fourth quarter, and his insight on where we are headed in 2008 and beyond, Frank will follow Victor with the detailed review of the numbers. And then, we'll open the call up to hear from you, so that we can take your questions and provide you with answers before ending our call today.

Now, it's my pleasure to turn the call over to Victor Limongelli, President and Chief Executive Officer of Guidance Software. Victor?

Victor Limongelli

Thanks, Bill. Good afternoon, everyone. It was a great quarter and an excellent year for Guidance Software. Let me begin by sharing some brief financial highlights with you before we begin discussing the details.

Reviewing our revenue performance, we delivered our 7th consecutive quarter in 10th consecutive year of record revenues. We are happy to report as well that excluding share-based compensation, we earned $0.08 per share in the fourth quarter and $0.11per share for 2007 as a whole.

We are pleased with the performance of the business in 2007. We are in the process of building a great company, a process that is well underway. Let me expand on some of the achievements of which we're particularly proud.

With respect to revenue, EnCase Enterprise continues to do well. We now have over 500 EnCase Enterprise customers, including major government agencies, over half of the Fortune 50 and over 100 of the Fortune 500. EnCase Enterprise is a deep platform for digital investigations across a network.

On top of that platform, we build high value applications to solve specific business problems. One of these products, EnCase eDiscovery, which is our highest priced and highest value product, saw explosive growth and record sales in 2007. In 2005, we launched EnCase eDiscovery in the fourth quarter and we had two sales. In 2006, we sold 29, and in 2007, we sold 51. As you might imagine, we have high expectations for EnCase eDiscovery in 2008 and beyond.

With respect to EnCase Information Assurance, which, like EnCase eDiscovery, runs on the EnCase Enterprise platform, it contributed significantly to our Q4 results. In December we closed the largest license deal in company history, in this case to a large federal civilian agency and EnCase Information Assurance was a big part of that deal.

In addition to the strong performance of EnCase Enterprise related products, we saw record orders this past year for our standalone produce, EnCase Forensic. It continues to be the leading computer forensics product, used widely by law enforcement and consultancies to conduct forensic investigations of computers.

So our software business, which, along with the associated software maintenance, constitutes approximately three quarters of our revenue, has done very well.

Our services businesses, comprising Professional Services and Training, both had excellent years. Training delivered record revenue and trained a record number of people in forensic investigations. We filled over 4,700 seats in our training classes compared to approximately 3,800 in 2006.

Professional Services likewise had an outstanding year, delivering record revenue and playing in a crucial role in ensuring that our customers are successful with EnCase Enterprise and EnCase eDiscovery.

Underpinning these sales successes are the tremendous strides we have made in software development.

Last year we upgraded our product management process and we have been increasing the number of software developers. Our development team continues to layer in new technology to EnCase, such as integration with disk or file-based encryption products, and continues to enhance our product line.

In fact, just this week we are releasing version 6.10 of EnCase, which includes some important new capabilities for information security purposes concerning direct access to RAM, as well as integration with a couple of encryption technologies. In Q4, we introduced an upgraded version of EnCase Information Assurance which continues to be targeted at the federal market.

And earlier this month, we demoed at the Legal Tech Conference our upcoming version 3 of EnCase eDiscovery. We are looking forward to releasing this product next quarter and we believe that the improvements in the product in its processing capabilities, its usability and workflow, and the optional connectors to content management systems will increase its value to customers and reaffirm our technical and market leadership. We believe that these technological improvements will help drive our business in 2008.

Looking ahead, we are optimistic about our business, both this year and beyond. We are executing on our plan, building out the EnCase platform, introducing new products that enhance its value to customers and solving significant business problems. The blocking and tackling the day-by-day execution by our employees is building our customer base and driving our revenue.

Our goal is to drive that revenue growth in an efficient manner. For example, we are leveraging our experienced sales people by introducing new entry level positions that will help the experienced sale folks prospect for new customers and up sell to existing customers.

Similarly, overseas, we have been expanding our distribution efforts by expanding the channel, and in some cases, having value-added resellers that, in addition to sales, can deliver training classes and perform software implementations.

As we grow, we have been obtaining and expect to continue to obtain economies of scale. You will notice that our selling and marketing expenses, as a percentage of revenue have been trending down, and we expect certain overhead costs, such as the expensive Sarbanes-Oxley compliance, to likewise decline as a percentage of revenue in 2008.

In short, while we are, of course, mindful of overall economic conditions, we see the news like everyone else. We, nevertheless, expect to have a strong 2008.

Before I turn the call over to Frank to discuss the numbers in detail, there are few other points that I would like to highlight.

First; in December, Gardner issued research on the e-discovery market. In that research, we received the highest rating, a strong positive, and we're described as the "correction tool of choice." Coupled with the Forrester Research earlier in the year calling us the de facto industry standard for remote desktop collection software, we believe we have received the most positive analyst coverage in the e-discovery market and we are, of course, very pleased by that.

Second, in December, we opened and expanded office and training facilities in Northern Virginia. This office marks the completion of an extensive build-out plan that we had undertaken in late 2006. In fact, we opened six new or expanded facilities from late 2006 to late 2007. We do not anticipate opening any new or expanded facilities in 2008.

Third, I would like to take a moment to welcome three new members of our Board of Directors. Bob van Schoonenberg, who is the Chief Legal Officer of Avery Dennison, brings to the Board the perspective of one of our target audiences; that is, top in-house lawyers at large companies, as well as his extensive knowledge of corporate governance.

Marshall Geller, who is President of St. Cloud Capital and former Senior Managing Director for Bear Stearns, brings financial expertise and significant experience on a number of public company boards. Stephen Richards, former McAfee CFO and COO and former E*TRADE CFO, brings both operational and financial expertise to the Board. We had our first Board meeting last week with the new Board, and it just confirmed for us that the company made excellent choices of electing the new board members.

Finally, our annual user conference, CEIC, will be held April 27 and 30 at Las Vegas, Nevada. This is a tremendous event. We expect over 1,000 participants this year and it is a great venue to learn about the latest products, investigated techniques and best practices for eDiscovery and digital investigations. Analysts or investors interested in attending should contact Bill Powell, our Director of Investor Relations. We will webcast our management presentation to investors and analysts at CEIC.

Now let me turn the call over to Frank for a discussion of the financials. Frank.

Frank Sansone

Thank you, Victor.

The financial information provided on this call will be presented on a non-GAAP basis only. Please see our fourth quarter press release for the reconciliation between the GAAP and non-GAAP results.

I am proud to report the results of the quarter. This was our 7th consecutive quarter of record revenue. We achieved pre-tax profitability for the second consecutive quarter and we achieved our first quarter of GAAP profitability. This is only accomplished through the hard work and dedication of the entire workforce and through our customers recognizing the value that our products and services deliver to their organizations.

For the fourth quarter of 2007, revenue was $22.5 million, up $5.5 million or 32% as compared to the fourth quarter of 2006. For the full year of 2007, revenue was $78.9 million, up $23 million or 41% over 2006 revenues.

As we mentioned in the last call, we will discuss our net result on a pre-tax basis only as a result of certain tax rates that the company may be subject to. I will expand on this later in the call. As such, pre-tax income increased to $1.8 million or $0.08 per diluted share for the fourth quarter of 2007, while last year in the same period we reported a loss of $300,000 or $0.02 per share. For the fiscal year, pre-tax income was $2.7 million, up $4.6 million from 2006.

Product revenue increased from $10.2 million in Q4 2006 to $12.3 million in Q4 2007, a 21% increase. For 2007, product revenue was $44.3 million as compared to $32.6 million in 2006, which was a 36% increase.

Enterprise license revenue grew from $7.1 million in Q4 2006 to $9 million in Q4 2007, a 26% increase. For the year, enterprise license revenue grew from $19.7 million in 2006 to $32.1 million in 2007, a 63% increase.

In Q4 2007, we sold 14 licenses of our EnCase eDiscovery and three of Information Assurance. In the fourth quarter of 2006, we sold 13 licenses of the EnCase eDiscovery and two of Information Assurance. For the full year, EnCase eDiscovery sales increased from 29 to 51and Information Assurance sales increased from 10 to 14.

In Q4 2007, we had 9 enterprise sales that were greater than $250,000 in license revenue as compared to 7 in Q4 2006 and 8 in Q3 2007. For the 12 months ended, these transactions increased from 16 in 2006 to 34 in 2007, and accounted for approximately 35% of our enterprise license revenues in 2006 and approximately 50% in 2007.

Highlighting the powerful pricing of our platform and related product sales, in Q4 we closed the single largest license transaction in the company's history valued at approximately $1.8 million.

Services and maintenance revenues increased from $6.8 million in Q4 2006 to $10.2 million in Q4 2007, a 50% increase. The fourth quarter has typically been a seasonally strong period for our services segments and that trend continued this fourth quarter. We experienced growth of 40% in Professional Services, 22% in Training and 83% in our maintenance revenues as compared to Q4 2006. These areas are continuing to grow as the usage of our software expands into new and existing customers and makes our users more successful.

Our fourth quarter 2007 gross margin was 73.9% and our operating margin was 6.4%. This was a 4 point increase in gross margin and an 8.8 point increase in operating margin in Q4 2007 as compared to Q4 2006. However, as compared to Q3 2007, our gross margin slightly decreased 1.4 points and our operating margin did not change.

For the 12 months ended, our gross margin was 73.2% and operating margin was 1.5%. This was an increase of 1.5 points in gross margin and 5.3 points in operating margins as compared to 2006. Furthermore, for the 12 months ended 2007, our product margin increased by 1.5 points and our services margin increased by 4.1 points as compared to 2006.

Operating expenses increased $1.2 million or 9% to $15.2 million compared to Q3 2007, and we are up 23% from $12.3 million in Q4 2006. However, operating expenses as a percentage of revenues decreased to 67.5% in Q4 2007 from 68.9% in Q3 2007 and 72.4% in Q4 2006. The increase in absolute dollars as compared to Q3 2007 was a result of seasonally higher commission and bonus compensation of approximately $500,000, additions to the allowance for doubtful accounts of approximately $600,000, and a depreciation expense increase of approximately $100,000.

For the fourth quarter of 2007, share-based compensation was $1.5 million, up approximately $900,000 year-over-year and up approximately $500,000 from the third quarter of 2007.

Cash and investment increased from approximately $35.1 million at Q3 2007 to $37.6 million. This increase is a result of a seasonal increase in cash collection and exercises of employee stock options offset by purchases of property and equipment.

For the fourth quarter, we were cash flow from operations positive of $3.5 million, and for the full year of 2007, we were cash flow from operations positive of $8.5 million, which was a tremendous result. In 2006, we were cash flow negative from operations for both the fourth quarter and the full year.

Deferred revenue increased 34% from $20.2 million at yearend 2006 to $27.2 million at yearend 2007, which has been primarily increased as a result of bookings of our subscription EnCase Forensic product line and our maintenance support services. As compared to Q3 2007, deferred revenue increased 2% as a result of increased deferral of our maintenance bookings, offset by increase recognition of previously reported enterprise term licenses.

We saw our sales weighted DSOs reduced to 59 days in the fourth quarter, improving from 68 days in the third quarter and 80 days at yearend 2006. Our sales weighted DSOs typically fluctuate between 60 and 80 days. In regards to our headcount, as of yearend, our full time headcount was 351 employees, and as we sit here today, we stand at 373. We expect to finish 2008 between 400 to 420 full time employees.

On an annual basis, our geographic mix shifted slightly as US revenues increased to approximately 77% of our total revenue in 2007 as compared to 75% in the prior year. Although international sales have increased on an absolute dollar basis, our domestic sales, particularly our eDiscovery Solutions, has outpaced our international growth.

Most notably, our 2007 sales in Asia increased to 120% as compared to fiscal 2006. The Asian market has shown to be accepting of our technology and message. It holds many opportunities for us going forward.

We clearly are pleased with our 2007 accomplishments and look forward to 2008. However, just like everyone else, we are keeping an eye on the macroeconomic conditions. While we are being cautious in our outlook for 2008 in light of the macroeconomic environment, we are not seeing the impact on our business.

As such, at this time, we are going to maintain and reiterate our 2008 annual revenue outlook of $94 million to $99 million and pre-tax non-GAAP EPS of a range of $0.11 to $0.24 per diluted share. And for the time being and as we move through the year, we will adjust these ranges as warranted. For 2008, we expect share-based compensation expense of $7 million to $10 million, resulting in a pre-tax GAAP EPS estimate of minus $0.32 to minus $0.05 per share.

In regards to our presentation of results on a non-GAAP pre-tax EPS basis, we are setting expectations on a pre-tax EPS basis in 2008 as a result of the expected impact by the anticipated reversal of a valuation allowance on the company's deferred income tax assets, upon the continued taxable profitability and the evaluations of our other issues and factors. Until this valuation is released, we expect varying effective income tax rates. Given the unpredictability of the timing of a potential release and effective tax rates, we believe that setting pre-tax expectations is appropriate.

In regards to share count, as of December 31, 2007, our basic share count is 22.9 million and our diluted share count is approximately 23.4 million. Our expectation is that this will increase approximately 300,000 per quarter throughout 2008.

Finally, I want to remind everyone of the seasonality in our revenues as has historically been reflected in our results. Our expectations are that revenue in Q1 will be down from what we have reported in Q4, which is consistent with our historical results. This will likely result in a reported pre-tax loss for Q1, be slightly unprofitable to profitable in Q2, and move to greater profitability in the second half of the year.

Please be mindful of this as you consider your analysis of our forecasted 2008 results. We believe with our results thus far, we are making headway towards achieving our objectives and look forward to continuing to execute on our strategic plan.

Thank you. And I will give you back to Bill Powell.

Bill Powell

Thanks, Frank. Before we move into our question-and-answer period, I'd like to recognize the newest members of our growing analyst community. We'd like to extend a warm welcome to, in order of coverage initiation, Mark Schappel of Benchmark Capital; Jonathan Ruykhaver and Rajesh Ghai of ThinkEquity; Kevin Buttigieg of Stanford Research; and Brian Gesuale and Matt Bugarin of Raymond James. With these additions, this brings the number of analysts who have provided estimates to First Call on Guidance Software to a total of 9.

Next, I'd like to let our listeners know we'll be presenting this Monday, March 3, at the Morgan Stanley Technology Conference being held in Dana Point, California. Following that, we will be on the road with Roth Capital Partners to meet investors in Minneapolis and Kansas City on March 5 and 6. Next, we'll be on the road with ThinkEquity to meet with investors in Boston on March 13 and 14. That will conclude our investor presentation and meeting schedule for the first quarter of 2008.

To arrange for meetings with us at these events, please contact your Morgan Stanley, Roth Capital or ThinkEquity representatives, and please follow-up with me directly, if you are interested in meeting with us, but are unable to confirm availability.

With all that said, it's time to hear from you. We'd like to take your questions. Operator, would you please tell our listeners how to register their questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question today comes from Philip Rueppel with Wachovia Securities.

Philip Rueppel - Wachovia Securities

Great. Thank you very much. Just a little bit of clarity on your commentary. You're obviously maintaining guidance, so you're positive about 2008, but you did talk about the cautious macro environment. Are you seeing any particular segments of your business, or customer delays or longer sales cycles, or is it really just that, in general, things could get worse later in the year?

Victor Limongelli

Phil, this is Victor. It's more of the latter. It's February still, and we feel good about our business. Things look good to us. But we're conscious of the news and everything that's happening in the macro conditions. And so, we're keeping eye on it. But we feel good about our business. Does that answer your question?

Philip Rueppel - Wachovia Securities

Yes, it did. Second of all, just as far as the mix between license and service, obviously, licenses grew less than services did in the fourth quarter. Is that just because of the more lumpy nature of licenses, or is that something that we should expect to continue that services and maintenance would grow faster on a year-over-year basis?

Victor Limongelli

Obviously, Q4 numbers stay where they are. Our expectation is to continue to drive our software sales and to get our growth out of our software. However, as you see, our services groups have been doing very well and are accelerating very quickly. I think that healthy growth out of both is what you should expect, and I don't think of any specific trend for any quarter, but we'll continue going forward.

And just a follow-up on what Frank was saying, we actually see our services business as a crucial strategic way for our software business. We had a very good quarter out of our professional services division, and what they do very often is go on to a customer site or a prospect site and deploy our software, and use it to accomplish a specific task. That's great, brings in revenue for us, it solves the customer's immediate problem, but it also serves as a paid proof of concept, where the customer can see the software working on their network. And we think that's a great opportunity for us to follow up on services engagements by achieving software sales later on.

Philip Rueppel - Wachovia Securities

That's great. Thanks. That answers the question. I'll pass this time.

Operator

Our next question today comes from Brian Gesuale from Raymond James.

Matt Bugarin - Raymond James

This is Matt speaking in for Brian. Congratulations on the quarter.

Victor Limongelli

Thank you.

Matt Bugarin - Raymond James

Thanks. I guess the first question is about your expenses as a percent of sale. They've been dropping nicely. I think they improved about 400 basis points from '07 to '06. I was just wondering, as you look into '08, how you see your operating expenses as a percent of sales, comparing to the decline that you saw from this past year.

Frank Sansone

Yeah. Obviously, our goal is to continue to drive the efficiencies in our model. We'd like to keep the momentum that we have, and what we're building here on the topline revenue that's flowing through straight to the bottomline. We have a couple of areas that we will be investing this year, specifically R&D group and some of our channel operations, and the inside sales group that Victor mentioned. However, we are not going to be expanding overall operating expenses to the same level that we had in 2006 for sure, and we expect that that is continuing to moderate.

Matt Bugarin - Raymond James

Okay. So, I guess you're kind of saying maybe in the same levels roughly as how you did in '07 from '06?

Frank Sansone

That would be about a good approximation if you're looking for a number.

Matt Bugarin - Raymond James

Okay. And then, I guess you guys had a really big deal, I guess, a $1.8 million sized deal. That's pretty large. And I was just looking, as you look into the pipeline, how do you see, I guess, deals in that size, or just in general, how that's grown over the, I guess, past six month or so?

Frank Sansone

Well, certainly deals of that size are same to us, because they show that we have the ability to provide great value to large networks. So we have deals larger than that that we're pursing, but we certainly don't consider that to be any kind of an average. It is a big deal for us, and that size will continue to be a big deal for us. We do report on a number of deals greater than $250,000, and we think that's a more appropriate metric, as you're likely to see them in that in multi hundred thousand dollar range rather than the multi million dollar range.

Matt Bugarin - Raymond James

Okay. I think that's it for me. I'll pass it on.

Operator

We go next from Kevin Buttigieg with Stanford Group.

Kevin Buttigieg - Stanford Group

Thank you.

Frank Sansone

Hi, Kevin.

Kevin Buttigieg - Stanford Group

Hi. Just a clarification on the larger license deal that you signed in the quarter, did you recognize that in revenues during the quarter or was that deferred to the balance sheet during the quarter?

Frank Sansone

No, we recognized it in the fourth quarter.

Kevin Buttigieg - Stanford Group

Okay. Second of all, wondering if you could talk a little bit about what you've been seeing in terms of sales to repeat customers, versus sales to new customers?

Frank Sansone

We continue to see a good healthy split between new and existing sales. Our goals of our sales group have directions to try to bring in new customers. They are incented to do so. I would say that for the future of the company to be able to allow us to have add-on sales going forward, on a given quarter, it may swing between new or existing customers. However, over the year, we've seen a pretty healthy split between the two.

Kevin Buttigieg - Stanford Group

Okay. Fairly equal, then?

Frank Sansone

Yes.

Kevin Buttigieg - Stanford Group

Okay. And then, it sounded like the hiring plan that you talked about earlier for this year, that that really was not going to be skewed towards quota-carrying sales reps, as it had been in the past. Is that a correct assessment?

Victor Limongelli

Yeah. Kevin, that's correct. We have some positions that that we'll be adding. We have about 70 quota-carrying right now, and we have a few open positions. You can figure that that number will be in the 70 to 80 range. If we filled every single position and there wasn't a single opening, it would be 82 under our current plan.

Kevin Buttigieg - Stanford Group

Okay. And then, do you feel that you've gotten the kind of productivity improvements out of the sales representatives that you'd hired back in '06?

Victor Limongelli

We do feel that we're getting productivity improvements out of them. One of the things that I mentioned, one of the positions that we did have this year is something that we are calling inside major account manager. We have 9 of these positions. They are entry level positions in the sales organization, and their role is to help the experienced sales people be more productive by prospecting, to setup meetings and by calling into existing customers, as you were alluding, to upsell them and get add-on business.

So we think that role, that position, will help make our experienced sales people even more productive in '08.

Kevin Buttigieg - Stanford Group

Okay. Thanks very much.

Operator

(Operator Instructions)

Our next question comes from Mark Schappel with Benchmark

Mark Schappel - Benchmark

Hi. Good evening

Victor Limongelli

Hi, Mark

Mark Schappel - Benchmark

Hi. Victor, could you just talk a little bit about the large deal and how that developed? The did that start off as a much smaller deal and just kind of grow throughout the sales process, or was it a very large deal from day one?

Victor Limongelli

It was a large deal. We were pursuing it for a while and it took a while to close. I don't want to give you guys the impression that it just popped off out of nowhere. Our sales team worked very hard for an extended period of time to bring that in, and did a great job on it. But it was a large deal. And as I mentioned, we have other deals that we pursue that are in that range. We think it's a great indicator that we're providing tremendous value with our software, because people won't be willing to spend a couple of million bucks if there wasn't a lot of value there.

Mark Schappel - Benchmark

I also believe in your prepared remarks you mentioned that it was a federal civilian deal.

Victor Limongelli

It was.

Mark Schappel - Benchmark

Did the continuing resolution issue extend that deal longer than initially anticipated?

Frank Sansone

It's an interesting thing, Mark. The continuing resolution ended in, I think, mid December and the deal closed like a week later. Now, we can't draw an exact line there, but we were certainly pursuing it for a while and weren't able to close it until December. So, hard to say precisely, but we're certainly happy that the continuing resolution is lifted and that they have a budget now.

Mark Schappel - Benchmark

Okay. And then, finally, the Info Assurance suite, I believe you said that there were two deals that were done in the quarter, and I think there were nine back in the third quarter. Is that just a normal seasonal pattern just because the September quarter is typically a big government quarter?

Frank Sansone

Absolutely, you should expect most of the sales of that suite to occur in the third quarter in any given year.

Mark Schappel - Benchmark

Okay. So we should not read anything into the nine to two number, then?

Frank Sansone

No. I think was three actually in Q4, but you should calculate it. It is mostly a Q3 product.

Mark Schappel - Benchmark

That's all from me. Thanks.

Frank Sansone

Thanks, Mark.

Victor Limongelli

Thanks, Mark.

Operator

Our next question comes from Jonathan Ruykhaver from ThinkEquity Partners.

Jonathan Ruykhaver - ThinkEquity Partners

Hi, guys. Nice quarter.

Victor Limongelli

Thank you.

Jonathan Ruykhaver - ThinkEquity Partners

Just for some clarification, you mentioned, Frank, that we should expect to see a pre-tax loss early in the year, and then, thereafter profitability improvements. Does this refer to GAAP pre-tax loss or does it exclude share-based comp?

Frank Sansone

Excludes share-based compensation. As you know, the seasonality in our revenues, how it moves throughout a year, that's how our numbers are going to be reflected, similar to how they were reflected in 2007.

Jonathan Ruykhaver - ThinkEquity Partners

Okay. So I was just looking at 2007, it looks like in the first half of the year approximately 46% were recognized in the first half of the year and the remainder, 54%, in the second half. That's kind of the way that we should see or expect to see in '08?

Frank Sansone

I would be happy without, but we are obviously not setting any level of guidance on that.

Jonathan Ruykhaver - ThinkEquity Partners

Right. Okay. And then in years past, obviously, there has not been specific budget loss [in-store] eDiscovery software. And I'm just wondering in the market today, with FRCP and other compliance issues, are you seeing increasingly RFPs written directly around eDiscovery, or is it still really a process of education, preaching the gospel and fighting for budgets before we get the customer to buy it?

Frank Sansone

The answer is both. We do see RFPs now where we didn't see them a few years ago. We do have people telling us that they asked for this in your 2008 budget and got approval for the new 2008 budget. That was a new thing. Never saw that before. But I don't want to minimize the fact that there is still a lot of education and there is still a missionary aspect to the sale to knock these down one by one and get new customers for the product. So, in general, the trend is more now than it was in the past, but it's by no means universal.

Jonathan Ruykhaver - ThinkEquity Partners

Right. I don't know if you've ever given this outlook in the past, but when you look at the EnCase Enterprise installed base, do you have any sense as to the penetration for EnCase eDiscovery, where you expect that to go over the next 12 months?

Frank Sansone

We do have a sense. I think I talked about in my prepared remarks, as of the end of '07, we had in low 80s in terms of number EnCase eDiscovery suite customers and 500 EnCase Enterprise customers. So that works out to be 16%, I think. So we definitely are pursing those other customers for upgrades.

Jonathan Ruykhaver - ThinkEquity Partners

Okay. Good enough. Thanks guys.

Frank Sansone

Thank you.

Operator

(Operator Instructions)

Our next question comes from Josh Jabs from Roth Capital.

Josh Jabs - Roth Capital

Hi, guys. Good quarter.

Frank Sansone

Thank you, Josh Jabs.

Josh Jabs - Roth Capital

You mentioned there was success in Asia, and it sounds like, at least it was one large customer, that US companies are seeing advantages in moving Enterprise platform overseas. You had mentioned also looking to a channel structure for some of those sales as well. Can you just give us a little more color on what's going on in the international market currently and what you expect this year?

Victor Limongelli

Absolutely, we sell through a channel in international market, except for the UK. We have a direct sales force in UK. But in other markets we sell through a channel. We have channel managers. We've got them sprinkled around the globe, one in Brazil, one in Dubai, Singapore, et cetera. And they manage channels in those areas.

And we have expanded the channel. We've also made the channel more involved with our company, by having training classes that they can deliver and also doing the implantations. So, that's our strategy internationally, and that's what we're pursuing. And we have added a few channel managers internationally.

Josh Jabs - Roth Capital

And so, if you have a large US customer and they go to one of the subsidiaries overseas, is that handled then through that channel partner, or is that something that's more direct through the company?

Victor Limongelli

If they're buying our software, and they're deploying it around their network, across their network, then it's usually going to be handled directly through our sales force. If there were a subsidiary overseas that was buying the software on its own, that might be handled through the channel.

Josh Jabs - Roth Capital

Okay.

Victor Limongelli

Does that answer your question?

Josh Jabs - Roth Capital

Yeah. No, that's good. Frank, you discussed the pre-tax non-GAAP EPS number of $0.08 for Q4. What is that compared to for the Q3 number?

Frank Sansone

It was $0.03, so up $0.05 from the previous quarter.

Josh Jabs - Roth Capital

Okay. And the ramp in stock-based compensation for 2008, was there a change in compensation package, or is this due to some of the stuff you're talking about, one, R&D development, and lower end sales and marketing?

Frank Sansone

Yeah. There was some change in the overall compensation package, and our new CEO, Victor Limongelli, has some portion of that. And just the overall growth and adding to the development cycle has changed our overall expectations for share-based compensation.

Josh Jabs - Roth Capital

Okay. Switching back to some of the opportunities here, you announced the NATO-M recently. That's a fairly complex network. Can we get a little bit more color on the rollout schedule and the potential size of that deal?

Frank Sansone

Sure. I was actually announcing the deployment that they have purchased in '07. So we have hopes of expanding that, but I can't speak specifically to the future with respect to that deal. It is complex, and that is an example of our product integrating with the SIM tool to pick up the correlated events from the SIM tool and go out and capture data to help them respond. So it's a great example of that, and our services team did a great job implementing that, and we're very pleased about it.

Josh Jabs - Roth Capital

Okay. And you mentioned integration with the SIM tool, looks like there were some partnership opportunities for you guys on some of the storage vendors, or possibly some things on the clients' side. Can you give us any idea of what you're trying to consider the core area where you're more likely to build a house, versus what makes sense to partner?

Victor Limongelli

Sure. We are looking to increase the interoperability of our software with other tools. So, I mentioned a little bit integration with content management systems. We'll be introducing the ability to search into document, and then Open Text LiveLink next quarter. Certainly, we think it makes sense to partner with those types of technologies that are widely used out in the corporate and government marketplaces.

We tend to look at technologies, as to whether we develop in-house or with partner. Is it something that we either do well, we have some expertise in it, or we could do well? If it's not, it probably makes more sense to partner there. We want and we view EnCase Enterprise as a platform to enable investigations across a network to solve specific business problems.

Now, we're building some high value things on top of that, like EnCase eDiscovery and EnCase Information Assurance. But there are other things that are outside of our core competency that we want to enable the capabilities. I'll give you a couple of examples. There's a company that has a picture, an image file, analysis tool, that they have built in integration for EnCase, and now you can use their tool to analyze images using our EnCase platform. We expect to have a partnership with the company that has a memory analysis application to help for instant response. We introduced a partnership with a company called Bit9 that has the world's largest hash database.

All of these things are to leverage our EnCase Enterprise platform, make it more useful for our customers, and make it more powerful. And we will do development if we're good at it, but we're perfectly happy to have others to do the development and make our platform more valuable.

Josh Jabs - Roth Capital

All right. Just then one last question, I'll get off here. I know the main forensics lab for the federal government, I read DHS uses your platform, it's going to standardize on the forensics platform. There is another quest out for the lab during Q4. Is that a deal that's gone through, and then, is that a continuation of that core program, or is that an expansion of the program?

Victor Limongelli

You know, Josh, I'm going to have to get back to you. I'll find out about that deal at a later date because I don't have the specifics at my fingertips.

Josh Jabs - Roth Capital

Okay. Great. Thanks, guys.

Operator

(Operator Instructions)

We'll hear next from Israel Hernandez from Lehman Brothers.

Israel Hernandez - Lehman Brothers

Hi. Good afternoon, everyone. Can you speak to your product roadmap and if any product introductions you have schedule and planned for 2008? What does that look like, and can any of those be a catalyst in the New Year? Thanks.

Victor Limongelli

Yeah. It's an excellent question. We have announced, as I mentioned, the new version of eDiscovery which we think is going to be a big driver. It's got some get great features, increasing the processing capability. We're going to have the XML load file format to transfer data over to attorney review platforms, global de-duplication, improve support for Exchange and Domino, and much improved usability and workflow. We think that's going to be a big driver for us.

We do have other products under development, but we haven't announced them yet. So I can't speak to them at this point. We have increased our development team as I mentioned, and we're doing that for a reason. We see good opportunity and we want to continue to build upon this platform, but the products aren't announced yet.

Operator

It appears there are no further questions at this time. I'd like to turn the conference over to Director of Investor Relations, Mr. Bill Powell.

Bill Powell

Thank you very much. I want to thank everyone for calling in today and for asking your questions. As always, I am available for follow-up. Please refer to the press release for both my telephone number and email address. Thank you so much for listening and looking to do this again next quarter. Thank you and good bye.

Operator

That concludes today's presentation. Thank you for your participation. Have a wonderful today.

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