Quest Software, Inc. Q2 2008 Earnings Call Transcript

Aug.18.08 | About: Quest Software, (QSFT)

Quest Software, Inc. (NASDAQ:QSFT)

Q2 2008 Earnings Call Transcript

August 5, 2008 5:00 pm ET

Executives

Stephen Wideman – Assistant Treasurer

Scott Davidson – SVP and CFO

Vinny Smith – Chairman and CEO

Analysts

Aaron Schwartz – JP Morgan

Tim Klasell – Thomas Weisel Partners

Walter Pritchard – Cowen & Co.

Derek Bingham – Goldman Sachs

Raymond Chem [ph] – Piper Jaffray

Kirk Materne – Banc of America

Brian Denyeau – Oppenheimer

Todd Weller – Stifel

Operator

Good day everyone and welcome to the Quest Software’s second quarter earnings release conference call. Today's conference is being recorded. With us today are Vinny Smith, Chief Executive Officer; Scott Davidson, Chief Financial Officer; and Stephen Wideman, Assistant Treasurer. At this time, I would like to turn the conference over to Mr. Stephen Weidman. Please go ahead, sir.

Stephen Wideman

Thanks very much and welcome everyone to Quest Software’s second quarter 2008 conference call. Of course, I am thrilled to have on the call with us today Vinny Smith, CEO; and Scott Davidson, CFO.

Scott and Vinny will breakdown the quarter that ended June 30th 2008 and then we will open up the call for questions. The call is being webcast today from our Investor Relations web site and you can get a copy of our press release issued just a short while ago on this web site as well. A replay of this call will be available on this site or using the instructions noted in our release.

Let me turn just now to our Safe Harbor statement. Some of the statements we make today may be considered forward looking, including statements regarding our anticipated revenue and operating margins in the future periods and other statements about our plans, prospects, and strategies. These statements involve a number of risks and uncertainties that could cause actual results to differ materially.

Please also note that these forward-looking statements reflect our opinions only as of the date of this presentation, and we undertake no obligation to revise or publicly release the results or any revision to these forward-looking statements in light of new information or future events. Please refer to our SEC filings including our annual report on Form 10-K for the year ended December 31, 2007 for a more detailed description of the risk factors that may affect our results.

Copies of these documents can be obtained from the SEC at sec.gov or by visiting the Investor Relations section of our web site. Also please note that certain of the financial measures we'll use on the call today, such as EPS, net income, operating margin, and operating income are expressed on a non-GAAP basis and have been adjusted to exclude various charges, including amortization of intangibles, share-based compensation expense, in-process R&D and expenses of our stock option investigation. We report our GAAP results as well as provide a GAAP to non-GAAP reconciliation in our earnings press release, a copy of which is available in the Investor Relations area of our web site at quest.com.

And with that, I will turn the call over to Scott.

Scott Davidson

Great. Thanks, Stephen, and good afternoon everyone. Overall the Q2 results were good. At the summary level, total revenues were $173.4 million for the quarter, an increase of 22% year-over-year. The non-GAAP operating income was $18.7 million; non-GAAP diluted earnings per share were $0.17. Q2 cash flow from operations was $24 million and deferred revenue was approximately $295 million, a $59 million or 25% increase from Q2 of last year.

License revenues were $75.3 million compared to $65.8 million in Q2 of 2007. This is a 14% increase year-over-year. Services revenues were $98.1 million, representing a $21.6 million increase or 28% growth over the comparable quarter for both our maintenance and professional services revenue.

On product lines, License revenue was driven primarily by our Windows and virtualization product areas this quarter. Maintenance revenues were driven by our database and Windows management product. Looking at the revenue mix for the quarter, License revenues represented 43% of total revenues while Services generated the 57% balance. This compares to a 46% License and 54% Services mix in the comparable quarter of last year. We are seeing continued success in the maintenance renewal efforts on a worldwide basis and in addition we recognized the benefits from both ScriptLogic and PassGo acquisitions to our Services revenue.

On a geographic basis, North American operations generated 58% of total revenues in the quarter with the rest of the world generating about 42%. For purposes of comparison the mix was 62% North America and 38% for the rest of the world for Q2 of ’07. Over the last several quarters we have experienced faster rates of growth outside of North America and Q2 continued this trend.

Moving to expenses, I would like to remind you that Q2 ’08 non-GAAP results presented today exclude the amortization of share based compensation, in-process R&D charge, amortization of certain acquisition related intangible assets and ongoing expenses associated with the stock option investigation. The earnings press release includes the reconciliation of the differences between the as reported GAAP and the non-GAAP financial results. The total expenses on a non-GAAP basis were $154.7 million which was a 26% increase over Q2 of 2007. Of this amount approximately 60% of the increase was related to the impact from acquisitions and higher costs relating to foreign exchange. We undertook various cost cutting initiatives in the second quarter of 2008 with the goal of improving our annual operating margins. These initiatives included work force reductions across all functions and geographies and of the affected employees were provided cash separation packages. During the quarter we identified approximately (inaudible) employees for termination under these initiatives. The severance costs recorded and paid in the quarter associated with these terminations was approximately $2.6 million. It should be noted that we chose to not exclude this $2.6 million in expense from our non-GAAP results during the quarter. So, therefore these expenses are included in both our GAAP and our non-GAAP results. It is expected that the impact from these reductions will begin to be realized in Q3. Average headcount increased by 14% compared to second quarter of 2007. If we exclude the workforce reductions, however headcount on the average basis would have increased about 17%. Effectively our Q2 expense initiatives on the headcount side have rebalanced our employee base to the Q4 2007 levels.

Sales and marketing expenses for Q1 was $79.1 million or 46% of total revenue compared to $64 million and 45% of total revenue in the same quarter a year ago. Of the increase two-thirds is associated with labor in the form of increased headcount including the impact from acquisitions and foreign exchange and higher travel expenses. Severance costs from marketing programs, advertising and trade shows accounted for the rest of the increase.

Research and development expenses in the second quarter were $37.7 million or approximately 22% of total revenue. This compared to expenses of $28.2 million or approximately 20% in the year-ago quarter. About two-thirds of the increase was related to labor including the effect from acquisitions in addition to higher costs related to foreign exchange.

G&A expenses were $20.1 million or 12% of total revenue as compared to $16.6 million which was also 12% of revenue during Q2 of last year. The costs associated with acquisitions, legal fees and G&A support accounted for 70% of the increase. Costs related to the previous restatement associated with the legal indemnification was approximately $600,000 in this quarter.

Looking at income, GAAP op margins were 2.5% in the quarter and GAAP operating income was $4.4 million. Non-GAAP operating income was $18.7 million generating an operating margin of 10.8%. Excluding the severance costs, non-GAAP operating margin would have been 12.3%. Other income net in the quarter was $3 million versus $6.1 million in Q2 of ’07. The primary driver of the year-over-year change was related to the decline in interest rates. In the previous comparable quarters of Q2 ’07 and Q1 ’08 we recognized a fully diluted benefit from foreign exchange gains which equated to about a penny and three pennies per share respectively. Due to the fact that foreign exchange rates were flat in Q2 of ’08 we did not recognize any benefits from foreign exchange this quarter on the O&E line.

Our GAAP effective income tax rate for the quarter was approximately a negative 11.3% compared to a 43.3% in Q2 of ’07. The comparative difference is the result of several factors including the projected mix of income between high and low tax jurisdictions and the closure of an internal revenue service examination of prior period tax returns resulting in a discrete benefit to Q2 of 2008. Our Q2 2008 non-GAAP tax rate was 18.7% compared to 32.2% in Q2 of 2007 primarily due to the forecasted mix of net income and the impact from the adjustment mentioned previously.

For the reminder of 2008, we are expecting a GAAP tax rate in the low 20s and a non-GAAP tax rate in the mid-20s. Also as mentioned specific to this year both the GAAP and non-GAAP tax rates are currently expected to be a few percentages higher, points higher next year. The GAAP net income in the quarter was $8.3 million and GAAP EPS was $0.08. The non-GAAP net income was $17.7 million and non-GAAP diluted EPS was $0.17. Fully diluted weighted average shares outstanding was approximately 107 million shares.

Now turning to the cash flow statement in the balance sheet as of June 30th, our cash and investment balances were approximately $420 million, CAPEX for the quarter was $2.4 million, cash flow from operations were approximately $24 million in the quarter compared to $7 million in Q2 2007. And DSO was 58 days, an 8 day improvement over the 66 days in Q2 2007. Deferred revenues were about $295 million, up $59 million year-over-year. About a third of this increase is related to the benefit of the acquisitions of ScriptLogic and PassGo Technologies.

Looking at the rest of 2008, we continue to see opportunities in primary markets, remain cognizant of current economic conditions, particularly in North America causing us to be cautiously optimistic. With that being said, our annual revenue guidance remains in the range of $705 million to $720 million. GAAP operating margins are expected to be an 11-12% for the year which implied a non-GAAP op margin of about 17.5-18.5%. The non-GAAP guidance excludes about $28.5 million of amortization of acquisition related intangible assets, $1 million for in-process R&D including about $1 million that was acquired in the May of 2008. $13 million of share based comp expense and $2.2 million in ongoing expenses associated with stock options investigation.

So that concludes the financial piece and let me turn it over to Vinny.

Vinny Smith

Thanks Scott. Okay I am going to review some of what Scott just went over and also try to give a little bit of color on operations and say on the things we are experiencing in the field with the products. So, again we experienced a, GAAP point of view, a 22% year-over-year growth with throughout the quarter ended $173.4 million. It is a 14% license growth on a year-over-basis and services grew about 28%.

American operations generated 58% of the total revenue. Rest of the world being 42% and as Scott mentioned this is a 4% delta moving away from North America and towards rest of the world. And this trend that we are seeing, we expect to continue to see. And there are two reasons that come to my mind what we are seeing increased percentage of business coming from outside of North America. One is we have historically had a lighter penetration in those areas. So, as our sales capacity grows it is able to get more or on par closer to levels penetration capability that we have had North America but it is still significantly behind. The other reason why we expect that number in that mix to continue with the shift is when we look at the kind of the macro economic climate the North America especially the commercial piece is a tougher environment, tougher climate than what we are seeing in other parts of the world.

In the quarter, our North America Commercial had a challenging quarter in Q2. While many of the other parts of our business including the US public sector, Asia and Latin America, and UK had a very nice quarter. We have an outstanding performance coming out of Germany and Scandinavian operations.

In Q2 we did 185 deals over $100,000 and this compares to 100 deals over $100,000 last year, a very nice increase. We had four transactions over $1 million in the quarter. Two happened to be in the applications area of our business. One was in the Java segment of that and the other was in the PeopleSoft change management. We had one Windows deal over $1 million, and one virtualization deal over $1 million.

Let me take a moment and reach the business areas where we describe the markets to you guys and give you a little bit of comment. On the database side, which is predominantly Oracle business, we are seeing pretty strong resiliency in the business. In that Oracle was our most by far and the way our most complex and difficult competitor and really we are doing with the evolution platform there we saw resurgent product SharePlex which is our high end database application. In the quarter, we gave the major new release in Q1. And in the third space, we are seeing still a very nice growth around our DBA suite which is a different module that we have come out with recently we are doing quite well. The Oracle business is not growing really fast but it is still holding firm, showing a lot of profit.

In the sequel area we have got better growth this year than we do in Oracle. And we really feel like we are coming into far, we hope to get more growth in the Sequel area in the database market. And that is because the people putting high end production systems into production and that’s when they can use some of the high end functionality products solving difficult performance problems in the sequel area. So, we anticipate that we should be able to see good growth in the sequel marketplace and it is exciting to be able to hold on and do a good job in the Oracle business in light of great deal of profit.

In the Applications space where we had two transactions over $1 million we also had a Foglight 5 release in Q2. And that is a big deal for us, we are working on that for many years. We think about Foglight business, monitoring products and we sell this into environments that have significant important day-to-day applications or J2EE or .NET applications, or applications that are highly end user focused and you are worried about the performance and failure rate that the end user are experiencing. And in the fourth area where we sell Foglight is in the virtualization area where we released some more functionality for monitoring the virtualization environment. So we have put a lot of money in this area of our business and we are very hopeful that we are going to see good growth, having a good start to the year with Foglight. Other comments in the application area is that, as I mentioned before we did a deal for our PeopleSoft change management for over $1 million and we did a deal for over $1 million in our Java tool family which was nice to see.

On to the largest area of the business, Windows is now larger than Oracle area of the business. We had a good solid quarter in this area of the business. The Active Directory Exchange migration business is the dominant categories for us and they continue to grow. Microsoft is emerging really as the only competitor, significant competitors into these larger categories. Every time they are going to look – we think a lot like Oracle in that they are going to be our most challenging and difficult competitor. But we remain really proactive in this area, we have got a lot to develop and moving forward on we think we can keep the distance between us and Microsoft at a significant level where we think we can continue to nicely grow these revenues.

In Q2 we had the Tech-Ed which is Microsoft’s Annual Technology conference. We had a prominent show and we won also IT Pro Magazine’s best of Tech-Ed with the breakthrough product called PowerGUI. This is a GUI environment for Microsoft’s PowerShell show what they released a while ago and are already within the first say 12 months in the market we have had over 100,000 downloads on the product. We haven’t begun charging for the product, and we don’t anticipate doing so and that we want to get a lot of people using the products and really enable them to become more virtual in their ability to use PowerShell technology from Microsoft and that is enhancing their experience we think we will be able to contribute to add to face value and we will find a way once we get enough users to make some money.

In the Exchange area of the business, it has been a great growth for us. And it has continued to expand the increased adoption of Microsoft’s Exchange 2007. We also see a shift towards unified communications where it is not just email but it is instant messaging and other types of messaging are being brought forward by companies like Microsoft, IBM, Cisco, and we think that there is going to be a real movement in the market from just email as a communications technique within companies and we are going to attempt our product family to be much broader and also we are going to push it be more heterogeneous in the future.

In other categories where we are smaller in the Microsoft area is the SharePoint space. This is Microsoft’s fastest growing area of their business. We brought forward a very complete product family over the last couple of years to manage SharePoint. We feel like we are prepared to handle the SharePoint space as they go into production and become mission critical. We think we are going to witness a reasonably larger market unfold very rapidly in front of us and we are best positioned to take advantage of that new market opportunity. So we have been planning that for many years. We made several acquisitions in the place as well as internal development and it looks good.

The fourth category of our area of products is the virtualization management suite. And in that area we have two lines. We have server side line and we have the desktop line. On the server side, and this area is referred to the Vizioncore, we have retained the name for the business unit. We go to market under Vizioncore and we surpassed in the quarter 10,000 customers using our products. We are adding approximately 200 new clients per week. So that means within a year we should get double that 10,000 clients. That is a significant number because we are servicing and selling products to customers in production. We tend to sell production products, so you can understand we are highly penetrated in the [ph] VMWare production base of customers.

In the quarter, we also landed our first seven figure deal around the virtualization space. We see the market diversifying with Microsoft’s Hyper-V release that we saw last quarter. Also we have got a number of hardware vendors and operating system vendors like Red Hat pushing Xen into the market and you have got independents like Virtual Iron, Citrix, and Parallel. So, it feels like the market is going to diversify and we are hopefully preparing for that diversification. We will make all of our money on VMWare today. In the future we think VMWare is going to release competitor to DR tool which is a concern and that will be interesting to watch what they bring together and whether they really target us as a competitor, whether they really like to keep us as a good solid partner, they really build unique and high quality solutions for the VMWare marketplace.

On the desktop side of the business, around virtualization we bought a company named Provision Networks couple of quarters ago. This is our move into client management. We are focused on providing a VDI solution that supports multiple high providers including VMWare, Hyper V, Xen and Parallel right now. We support customers that are free to run any high provider that they choose to in the back end and we give them the VDI technology to enable to support those multiple high providers. In the quarter, we had the largest VDI deal ever with just under $1 million. We also integration and support from Microsoft Hyper V in the quarter and we are in a very strong technical position around our VDI product line and we have to figure out how to move to the market as fast as possible because this is a new marketplace for us. We have not been a client side provider historically, but we are feeling that the client is merging with the data center back end server which is historically our strength and we decided to go chase this opportunity of the emerging new style of desktop and server coming together. So, those are the four areas of the business. Database as I said did pretty well, applications had a couple of nice deals in it with a couple of good other events in the applications space, Windows was strong in the virtualization management coming together quickly and rapidly.

On the (inaudible) concerned we closed the quarter with 3336 people. This includes the subsidiaries. This is 122 people fewer in Q1. Obviously as Scott mentioned we had a layoff in the quarter. We are fortunate that we implemented those expense reductions, it is hard moving up to do that and we take these things very seriously because we really care about the quality of experience from employees. We felt like we need to do this, we need to get head of things, and very difficult for us to see sales weakness within the quarter. So, I would like to tell you it is more enough to see a tough quarter and we pushed for layoff, but we are not able to do that because we don’t know how the quarter is going to turn out in the last couple of days. But we felt – we just had the feeling that it was time to get prepared and kind of hunker down for some tougher times. So we made this initial cut we hope it is only the significant cut that we need to make, but we are prepared to bring our cost structure in line according to how the business is performing. So, we got together and thought that was the right thing to do and with hindsight we timed it perfectly because it was a challenging quarter especially in commercials as I mentioned.

Let me stop here and open up the call for questions for Scott and I and then I will do the conclusion.

Question-and-Answer Session

Operator

(Operator instructions) We’ll go first with Aaron Schwartz with JP Morgan.

Aaron Schwartz – JP Morgan

Good afternoon. Scott, I was wondering if you could just walk through the margin profile in the back half of the year even if we exclude the cash severance charge in OpEx. It still looks a material step down in the cost. I am just wondering outside of the headcount restructuring you just talked about other facilities or there is some other things that you can get us comfortable with the cost structure in the back half?

Scott Davidson

So what you can end up doing is if you back out the 2.6 from Q2 you are going to look pretty close to flat with Q1 on the expense side. As I said in the prepared remarks, most of the effect of the reductions that we had took place late in the quarter. So, there wasn’t much of any impact within Q2. So, you sort of look at Q3 and Q4 they are probably – Q3 is going to be probably be a little bit of a step down from where you were in Q1 and Q4 may be up a little bit from that just to the extent if we have higher working commissions associated with that up a little bit. But in order to get to the range we are talking about. If you are at 7.20 [ph] as an argument sake say on the revenue line your expense profile is going to have to be somewhere roughly six or underneath that. So, you are talking about sort of a down sequential Q3 on the expense side and up flattish to may be just a little bit slightly up from that in Q4.

Aaron Schwartz – JP Morgan

Okay given commissions are may be more seasonal to Q4. Are there some other things that offset that in Q4 to stay sort of in that flattish range?

Scott Davidson

There are other things we talked about the headcount reductions that took place actually in Q2 and there are other expense reductions things that we have potentially on the table to turn the knobs on so to speak by travel for example and other elements of that Vinny alluded to. So there are other expense management aspects that we can deal with. On the upside of expenses, primarily in any of the upside of expenses you would expect to see – it is really going to be commission related in Q4. It shouldn’t be anything else specifically.

Aaron Schwartz – JP Morgan

Okay on the tax rate, I wanted to make sure I understood it correctly. Did you say mid-20 for Q3 and Q4 or mid-20 for the year?

Scott Davidson

Well, the annual tax rate we provide quarterly guidance because it kind of moves around quarter to quarter. But based on where we are right now you can assume if you take the Q2 number you should assume the mid-20s for this year on the non-GAAP.

Aaron Schwartz – JP Morgan

Okay that is helpful. And then product related question on the APM side, it is good to hear some transactions there. Do you think that it is right foot to some select opportunities or do you actually have a pipeline where you think you can see sustainable in that segment going forward?

Vinny Smith

We definitely have a pipeline to be able to show good growth for the end of the year. The trick for us is to try to figure out how to grow this overall business year-over-year and not just the second back half of the year. So, we anticipate having a strong back half. We are also putting programs in place to try to keep up, enhance the pace of the business. So we can get some good growth next year.

Aaron Schwartz – JP Morgan

Thanks for taking my questions.

Operator

We’ll go next to Tim Klasell of Thomas Weisel Partners.

Tim Klasell – Thomas Weisel Partners

Good afternoon everybody. First question has to do with probably the environment out there. It seems like you had reductions in force during the quarter, you maintained sort of the full year top line revenues sort of seems like there is a little bit of disconnect. How do you feel about the overall environment today then where you were say three months ago?

Vinny Smith

We are a little bit nervous that your promotions is going to set at especially in the UK a little bit more like what we are seeing in North America. As far as the disconnect is concerned we do have some ground that we need to make up and we did our internal plan in Q2. But we have got a decent rate on Q3 and people are optimistic although like I said in the early part of the call it is hard to read these things that you don’t really know until the last tick. So, it is a little bit challenging to get a good read on it but we have got bullish sales teams out there and we had a good July. So, I don’t think we need to do another lay off right now. But we saw a real strong and we will do that to get things in line relative to other business. So, we are just a little bit watching, waiting and seeing how Europe responds. Europe really had a good quarter.

Tim Klasell – Thomas Weisel Partners

(inaudible) share buyback.

Vinny Smith

Tim, let Scott say a little bit more on that.

Scott Davidson

Let me try to give you a little bit more color. In the prepared remarks one of the things I talked about was of the last several quarters we have seen Europe in particular driving a lot of the upside that we have seen and some of that has been with bigger deals. So, within sort of the 7.20 number the way we are looking at the year, the question is does that continue especially when Q3 is all quite time in Europe on an annual basis that is sort of a slower time. So, while we don’t see anything particular in Europe that causes us concern at the present time. It is just an element of risk because that is really have been driving a lot of the upside especially on the bigger deal size. Of note it is pretty interesting because we did some of the larger deals that we did this quarter were actually financial services driven which seems somewhat odd given that current environment. But when you look at those deals a larger proportion of those deals were actually in Europe. So that kind of is an offset if you will but that sort of the backdrop that we were thinking to help you understand.

Tim Klasell – Thomas Weisel Partners

The follow up question was the share buyback. Any update there?

Vinny Smith

We certainly looked at it. We are going to go back whether that is a good move and we looked at some larger acquisitions recently where we then thought about utilizing some debt, going out pricing debt and we were shocked some of the pricing we got. So we are little bit on the fence but we are hoping to make a decision coming up here within this quarter here Tim. So, but like I said we have to balance all these factors of acquisitions versus price of debt versus doing buybacks.

Tim Klasell – Thomas Weisel Partners

And then one final question, the SEC investigation can you give us an update there?

Scott Davidson

We made the submission several months ago, we are waiting feedback from the SEC but we haven’t got any news from that.

Tim Klasell – Thomas Weisel Partners

Okay good enough. Thanks guys.

Scott Davidson

Sure.

Operator

We’ll go next to Walter Pritchard, Cowen & Co.

Walter Pritchard – Cowen & Co.

Just specifically around the margin ramp that you are looking at the second half. Can you just help us out with what sort of headcount that you are thinking? Is it basically flat heads for the next quarters or increase that up a little bit?

Scott Davidson

When we took out the roughly 122 people we had modeled in some add backs. So, I am sure there will be some incremental heads. On the aggregate but I don’t have a specific number that we clearly are not going to add back in the entire amount any way to get the margin numbers. But there is a small proportion of that may be 20%.

Walter Pritchard – Cowen & Co.

And then as it relates to just around the stock comp I noticed that you raised that up in the GAAP versus non-GAAP numbers. What was the reason for that Scott?

Scott Davidson

We had the there is the restricted stock units that go to executive officers that kicked in during the second quarter of this year. So, accounting for those RSUs the stock based comp would be accounting for that but starting in Q2.

Walter Pritchard – Cowen & Co.

Last question around Q2 in license, I mean it seems like there has been a pattern in the last couple of years license being down sequentially which is different than most companies in your sector. I am just wondering it is something that has been preface, I am just wondering either one of – what is the reason behind that? It seems like usually a stronger Q2 and then it is pretty difficult for your peers.

Scott Davidson

It is sort of an interesting dynamic. Going back and looking and part of the analysis I did back and looking at it over the last three years and as you know this quarter we are down 3.8 million, in 2007 it was down 3 million if you back out that change related to the change in circumstance. Then back in ’06 it was 3.3. So, it has been consistently in the three million range. On an historic basis, I would say that the reason for it had been the related to sort of big Q4s that were then recognized in Q1. So you remember we changed the revenue recognition model for certain reseller transactions and that is clearly taking effect back in Q1 of ’07, but I still think we are seeing that transition take effect over this year as well. There is still a decent amount of deals that get deferred until cash is collected. So, we have certain entities that are still on cash basis and I think in Q1 we just have a different bookings profile than other companies. But it has been pervasive over the last couple of years actually.

Walter Pritchard – Cowen & Co.

Thanks.

Operator

Thank you. We’ll go next to Derek Bingham with Goldman Sachs.

Derek Bingham – Goldman Sachs

Hi, thanks. But the, Scott, OpEx progression you took us through for the back half, is it your idea that would get your model to the mid point of the range of your operating margin guidance?

Scott Davidson

The 17.5 [ph]. It should.

Derek Bingham – Goldman Sachs

Okay. And then product wise what came in below your expectations in the quarter?

Scott Davidson

Vinny you want to take that one.

Vinny Smith

Did you say which product is your weakness?

Derek Bingham – Goldman Sachs

Yes. Which one may be perform quite well as you had expected going in?

Vinny Smith

In the applications basically a number of big deals overall did not do as well and then we could have done a little bit better in the database area. So, we are seeing like up and downs. Some products are up and some products are down in the database area which is causing some optimism but it is still a challenging market when the platform vendor is leaning and the way they work with us. So, that is where I think the weakness is. It was not in Windows, Windows could have been a little bit better and virtualization both are pretty strong.

Derek Bingham – Goldman Sachs

In database, does it lean one way or the other, management versus desk?

Vinny Smith

It is starting to cloud those lines because so many of our DB or Toad users or DBA managers now we have been morphing our products under the Toad umbrella. So, we have been pooling our traditional DBA products out of family products and putting them as modules in Toad. So that the distinction between the two is not specific.

Derek Bingham – Goldman Sachs

Thank you.

Vinny Smith

Welcome.

Operator

We’ll go next to Mark Murphy of Piper Jaffray.

Raymond ChemPiper Jaffray

Raymond Chem [ph] for Mark Murphy. And how would you characterize the response to Oracle’s recent price increase for the Oracle database. Is it causing any pricing activity to switch over to Microsoft Sequel server database? Do you see any effect that will potentially benefit Quest?

Vinny Smith

I don’t think pricing is really going to shift the market pretty in marketplace and people need to get the discount that they need to get when they buy. And Microsoft products on the database side when you get to the net-net price kind of with the Oracle. It has not been that longer that Oracle is trying to push this new pricing model or increases. So I haven’t heard too much feedback from that and as far as we always benefit when there is a bit of heterogeneous competition in the market place. And so that is nice to see that there is not just one totally dominant vendor and I think that always help management companies. So, but I don’t think the pricing is going to shift the market that much.

Raymond ChemPiper Jaffray

You just mentioned some of the changing dynamics within the virtualization marketplace. Does that any of that change your assessment or go to market strategy within your virtualization business?

Vinny Smith

That market is moving in a much more rapid pace and we are adjusting plans literally every couple of months trying to figure out and see which other high providers are going to take hold, which technologies are going to be put in use that we are in the market. And on the client side what portion of the VDI technology that customers want to embrace fastest and what high providers they want to use, pricing issues. So, we are shifting our resources to try to capture the market as best we can. Those adjustments are really happening every quarter.

Raymond ChemPiper Jaffray

Can you provide an update on the self carrying quarter headcount stands and do you intend to add more in the second half of ’08?

Vinny Smith

Scott, do you know that number.

Scott Davidson

We haven’t broken out that number and we don’t anymore. I would say from a directional perspective. I don’t think that number in the aggregate changes that much. I think what you would see if you looked underneath it is a little bit less of the traditional direct quarter carrying headcount whether they are outside of the offices as we speak more through the model. Little bit lower cost model. But head wise I don’t think you would see much of a change.

Raymond ChemPiper Jaffray

Okay. Thank you.

Operator

We’ll go next to Kirk Materne with Banc of America.

Kirk Materne – Banc of America

Vinny, follow up on sort of your statement around some of the uses of cash. In terms of what you guys are debating with the Board, over the past few years you guys have done a fair amount of M&A clearly that hasn’t been returned to shareholders in terms of your stock price performance of four different groups of businesses. I guess at these levels I think you guys will probably be around the 15% cash flow yield tomorrow. How can the Board not consider Quest the best use of your own cash, I mean your own stock? I think you guys have had great acquisitions but I failed to see the reasoning in terms of looking at a big one given when your stock is spread.

Vinny Smith

When you say the big one you mean to say the big acquisition?

Kirk Materne – Banc of America

Meaning you said that you are looking at things that are on the larger side and raising some debt, addressing the capital structure that way I guess what is the thought process behind that when your stock has been around these levels for a few years and frankly on a cash flow basis is now exceedingly I guess cheap is the way we put it.

Vinny Smith

We are under evaluation, whether to do a buyback, whether to preserve cash. We are evaluating some larger deals, larger than we have historically done. We went out and looked at debt markets and we are perplexed with the cost of debt these days. I don’t know whether you guys are looking at it but it is really almost non-viable. So that put us in a little bit of a box, that we try to go buyback shares, do some acquisitions. And that’s what has been done for now. But I appreciate your point that buying back shares I think it makes a lot of sense and we should get to it and we are not going to do these acquisitions.

Kirk Materne – Banc of America

When you guys are looking at acquisitions on the bigger side given that you have a pretty disparate groups of businesses, I know you can’t discuss specifically focus on but what is the idea of going out and adding more complexity to your business model versus just – even without buying back shares without sort of honing on what you have to do. Getting these four businesses put together or I guess better situation or get more leverage out I guess is the best way of putting it.

Scott Davidson

It all depends on what the acquisition is in certain cases acquisitions like Leeda [ph] in the past we have got an immediate leverage or quick leverage out of it. And then we have done tangential acquisitions that have had varying degrees of success. It is not so much the magnitude of acquisitions that we are looking at. We want to do any acquisitions going forward that gives us that leverage. Some of the things that we are looking at today are just a little bit of larger in size than there is in the past. So, we are not looking at specifically adding more complexity. The things that we re looking at in the sweet spots of the areas that we currently are. So, we are not trying to do anything that is for example in the security space which we don’t really have much knowledge around. So, you are going to see – the types of acquisition the things we are considering presently would be those that if we get down or move forward on them you would ideally understand that exactly why we did it because it fits into our core spaces and core competencies. We are now looking to increase the degree of difficulty in anyway.

Kirk Materne – Banc of America

Okay, I appreciate the color. Thanks.

Operator

We’ll take our next question form Brian Denyeau with Oppenheimer.

Brian Denyeau – Oppenheimer

Scott, just a housekeeping one. Your margin guidance for Q2 2008, does that inclusive or exclusive of the 2.6 million of the restructuring costs?

Scott Davidson

That is actually inclusive.

Brian Denyeau – Oppenheimer

In terms of the leverage you are looking to pull in the second half of the year, is it fair to say that you are expecting the to be the greatest pivot point in terms of the cost in the second half of the year?

Scott Davidson

It is for two reasons. Number one you get underneath the reduction in force so we had the biggest impact from headcount perspective was S&M line and clearly on the potential of increasing that. That’s the biggest pivot point because that’s where the commission aspect goes through as we have upside on the revenues. So, both ways that is an accurate statement.

Brian Denyeau – Oppenheimer

And on the marketing side, how quickly can you start to taking off for the second half of the year?

Scott Davidson

Most of our marketing – if you sort of extract out the sales component from the marketing component of that line the predominant dollar amount is on the sales side. Specifically the marketing piece is a smaller subset of that. So within marketing there are heads associated with that clearly and there is what I call the discretionary marketing spend. So, programs whether they be channel development or traditional marketing activity. Those that are not committed already can be slowed down or shut off. Usually you need a quarter. Heads we have addressed some heads already but like I said you won’t see some of that until Q3. But when you think about the S&M spend it is predominantly on the sales line specifically and it is commission and share heads. One of the things I mentioned early is we are trying to get a little bit more of a lower cost model on the sales side and taking more products without sales model for example. And that may not have a direct head impact with respect to people leaving the company but their cost structure is lower.

Brian Denyeau – Oppenheimer

Where would you generally see you are in terms of perhaps you are comfortable with where you are in overall sales productivity at this point? And how much kind of low hanging fruit do you have to pick there in the next few quarters?

Scott Davidson

It can always get better. I wouldn’t say that it is a low hanging fruit. I mean I think it depends on the market that you are in and one of the elements that we have is don’t forget we are sort of back to the future in the sales model. So we have changed the sales model in the middle of Q4 of ’07. So now we are getting that sales model back on track. So, I think we feel pretty good about where we are. But regionally within the US in particular there are areas where we need to work whether it is model driven or headcount focus driven. So there is a lot of things we still need to do on the sales line in particular. So, is there a low hanging fruit, I don’t know that I could say that there is because in this market I don’t think anything is easy. It is about trying to get more efficiency out of what we have on the sales line and every line for that matter. It is just not sales focused. It is just as well in the G&A line.

Brian Denyeau – Oppenheimer

Okay great. Thanks a lot.

Operator

Thank we will go next to Todd Weller with Stifel.

Todd Weller – Stifel

Just a question on the philosophy of acquisitions versus share buybacks. I mean I think you guys have certainly been very inquisitive over the years the most part has been it has been a good strategy although your stock has been relatively flat for an extended period of time. So, from a shareholder value perspective I am just wondering how you think about that and especially with the stock given the evaluations where it has been trading, while you don’t think buying back stock would be in the best interests of shareholder value? Thanks.

Todd, it sounds like the same question that Kirk had asked earlier. I don’t see that there is a different answer to it frankly. I think from a philosophical perspective I mean in the direct fashion we didn’t say that we are not going to buy back stock. What we said is that we are looking at a couple of different things for the uses of cash. Buyback of stocks is clearly one of those things that we have evaluated. It is right at this point a timing issue whether we look at certain acquisitions and move forward with them and/or buy stock at the right period of time. From a cash flow basis, don’t require $424 million to run the business. With that instead we have got say 100 of that outside of the US. So, it is not as tangible with respect to easily put your hands on it. But I think philosophically speaking if we find the right acquisition that Phil holds or Dallas we are having certain areas we think that is historically been a better return for us. With the stock where it is at, that is the discussions we have had internally on the buyback. So, it is in discussions is what I can tell you. There is nothing to announce today on that matter.

Operator

Thank you. At this time, we have no further questions I would like to turn the program back over to Vinny Smith for any additional or closing comments. Mr. Smith, your line is open.

Scott Davidson

We are done with the questions.

Vinny Smith

Sorry about that I was disconnected for a while. So, we are at the concluding portion.

Scott Davidson

Yes.

Vinny Smith

I will finish off then. Two things for me to come to mind are on the quarter, we have gone through talking about uses of cash and margin and running the business, we have run the business the last couple of years and we are seeking ways to try to throw off more cash and increase profit at the same time to achieve sustainable long term growth. The balance is tricky and there is everyone has different feeling on how to achieve those things but we have done well and that is on the back of our employees. Our employees have done a wonderful job of servicing our customers in unique ways. One of the things that stands out for us at Quest is we have alternatives. Primarily due to work perform with the customers over and over again customers come back and give us repeat business and that is where we make all of our profit. It is on the repeat customer business. So, I want to thank the employees for that type of commitment. Continue to grow the company over the last 10 years and hopefully over the next 10 years we want to maintain the culture of focus on the customer and focus on the employee and do a good job for the shareholders as well.

With that, I would like to finish the call and thanks for listening.

Operator

That does conclude today’s conference. You may disconnect your line.

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