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Executives

Keren Ackerman – Director, IR

Joe Cowan - CEO

Max Carnecchia - President

John Calonico - SVP, Finance and CFO

Analysts

Derrick Wood - Pacific Growth Equities

Chad Bennett - Northland Securities

Mark Schappel - Benchmark Company

Barbara Coffey - Kaufman Brokerage

Brian Murphy - Sidoti and Company

Nate Swanson - Bank Equity

Interwoven, Inc. (IWOV) Q2 2008 Earnings Call Transcript July 24, 2008 5:00 PM ET

Operator

Good day, everyone. Welcome to the Interwoven Second Quarter Financial Results Conference Call. Today's call is being recorded. At this time I would like to turn the conference over to Keren Ackerman, Investor Relations Director at Interwoven. Please go ahead.

Keren Ackerman

Thanks Erica. Good afternoon, everyone and thank you for joining us as Interwoven discusses it's results for the second quarter ended June 30, 2008. With me on the call today are Joe Cowan, Interwoven's Chief Executive Officer; Max Carnecchia, our President; John Calonico, our Chief Financial Officer. Joe, will provide an update on our strategic progress, Max will summarize our Q2 business highlights and customer momentum and John will review our second quarter financial results as well as provide our financial outlook for the third quarter of 2008.

Our presentation today contains forward-looking statements that involve risks and uncertainties. These include expectations regarding the expected timing of the closing of our proposed acquisition of Discovery Mining Inc., the financial impact of this proposed acquisition and other forward-looking statements about our financial outlook, products and business developments. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. Some of those risks are mentioned in today's filings with the Securities and Exchange Commission others are discussed in our Forms 10-K and 10-Q, all of which are available at www.sec.gov.

On today's call we will also be presenting non-GAAP financial information. This information is not calculated in accordance with GAAP and may be calculated differently than other companies’ non-GAAP financial information. Qualitative reconciliation’s of our not-GAAP financial information to the most directly comparable GAAP financial information, appears on our web site at www.interwoven.com in the investor section and in today's press release. Also we are providing guidance for the third quarter on a non-GAAP basis with a reconciliation to GAAP appearing in today's slides.

Now, I would like to the turn the call over to Interwoven's Chief Executive Officer, Joe Cowan. Joe?

Joe Cowan

Thank you, Keren and good afternoon everyone. Folks we had a record second quarter. Interwoven future results were outstanding and we're excited to update you today on a number of developments across our business.

First, I would like to tell you about our record second quarter. In the quarter, revenues increased 16% from last year to $63.2 million, the highest revenues we've ever reported in a single quarter. And we increased our non-GAAP net income by 23% to a record $8.3 million. We further expanded our large customer base with over 100 new customers. And we enhanced the strength of our balance sheet by increasing our cash to $187 million. Our record second quarter financial performance, strong customer traction and increasing market recognition, all validate our strategy in which we are focused on being the best of breed provider in the high growth markets we serve. These markets are holding up well despite the challenges of the broader economy and we see substantial room for growth in each of these markets. Also our clear leadership position in each of these gives Interwoven a unique opportunity to continue to capture an even greater share of spending from customers in each of these markets. Max and John will have more details about our record Q2 performance.

But, now I would like to turn to our second exciting topic, which is a terrific next step in the strategy I just mentioned, the proposed acquisition of Discovery Mining that we announced this afternoon. We are looking forward to welcoming the employees of Discovery Mining to the Interwoven team. You will be joining a company with a proven track record of execution and a strong heritage in helping the world's leading organizations unlock the value of their content.

We are very excited about this acquisition and here's why: Discovery Mining is a lead provider of software as a service solution or E-discovery to professional services firms and corporations and was ranked by law firms among the top five E-discovery service providers in a recent report. Discovery Mining has worked with over half of the AM Law 100 firms as well as a number of Fortune 500 corporations. Litigation and investigations take place today in the midst of an information explosion of unprecedented scale.

Documents and e-mails related to an individual case or investigation can easily number into the millions and must be accurately processed, reviewed and produced under crushing time pressures. Most firms do not have the infrastructure to handle large volumes of Discovery data and are turning to companies like Discovery Mining to manage the E-discovery process.

According to Forester, the E-discovery market was $1.5 billion in 2006 and will grow to almost $4.9 billion by 2011, an increase of 238% over that five-year period. We believe the E-discovery market is highly fragmented and we plan to bring leadership to this market by leveraging our strong brand and intimate relationships with law firms and other professional services organizations. Upon closing, Discovery Mining service will be immediately available to over 1,700 professional services firms and corporate legal departments who use Interwoven today.

We believe Discovery Mining also provides an entree to firms not yet using Interwoven and we will aggressively market the service to those organizations. Interwoven has agreed to pay approximately $36 million in cash for all outstanding shares in vested stock options of Discovery Mining and will assume certain existing employee stock options. In addition, Discovery Mining's 51 employees will join Interwoven. The acquisition is expected to be completed during Q3 although it is subject to various customary closing conditions.

I will close with a few words about the momentum we are experiencing in our web solutions business. In its latest market scope report on the web content management industry, research firm Gartner, provide a clear validation of our vision to offer the industry's most comprehensive solution to create, deliver and optimize content for online businesses. As the only enterprised focus vendor to receive a strong positive rating and report, Interwoven is now the hands down winner in helping companies deliver compelling, targeted customer experiences over the web to maximize online business performance. Our second quarter results are proof positive that our focused strategy is working.

Now let me turn the call over to Max. Max?

Max Carnecchia

Thank you, Joe. As Joe mentioned we once again posted record financial results in Q2, which is now our 19th consecutive quarter of year-over-year revenue growth. While the challenging economic environment concerns us during Q2, our customers continued to allocate budget dollars to Interwoven.

In Q2 we grew revenue 16% year-over-year up from the 11% year-over-year growth we posted in Q2 of last year.

Turning to the numbers we added 106 new customers in the quarter. Today Interwoven counts nearly 4,400 customers in over 70 countries around the world. In Q2, some of the world’s best-known brands have put Interwoven at the core of their content strategies. Some great new customer wins in the quarter included, among others: Actelion Limited, the AmeriHealth Mercy Family of Companies, BCM [Handley] Wallace, Chadbourne & Parke, Cole Schatz, Jet Airways India, Liberty Mutual Group, McGraw Hill, Panasonic, Pearson PLC, Sanofi Aventis and Southwest Airlines.

Our repeat customers drove incremental value from their existing Interwoven investments by acquiring more capabilities from our growing product portfolio and by deepening the Interwoven footprint in more business divisions across their organization.

We experienced strong re-orders from existing customers such as Banc of America, Belgacom, British Telecom, Delta Airlines, Discovery Communications, Fidelity International, LexisNexis, Rogers Communications and Sky Italia, just to name a few, as well as professional services firms such as Bond Pearce and Debraw Blackstone Westbrooke.

Let me share some additional color about some of these fantastic wins starting with our professional services industry solutions business. One emerging trend is our ability to capitalize on the expanding demand for legal services in Asia-Pacific. In the second quarter we added firms in a number of countries in the region including Singapore, Malaysia and India. These firms are turning to Interwoven's best of breed matter-centric collaboration platform, to enhance their competitiveness as they expand their operation.

An example of one exciting win in Q2 is Khattarwong, a leading law firm based in Singapore, who chose Interwoven work site along with our advanced solutions for collaboration and e-mail management to leverage knowledge resources more effectively across their distributed organization.

Now, the firms professionals will be able to collaborate on documents seamlessly across multiple locations further driving efficiency and maximizing value to the client. Closer to home, Cole Schatz, purchased Interwoven's marker leading solution for managing the electronic matter file, integrated with our highly rated records management solution. When selecting Interwoven to replace their existing system, Cole Schatz gave our solution high marks for both front-end usability and integration with internal IT systems.

Last quarter, I commented on two existing wins for Interwoven universal search. We are pleased with the way customer interest in this offering continues to build and several recent wins included Bond Pearce and Debraw Blackstone Westbrooke. These firms plan to fully leverage their information assets by deploying Interwoven universal search to unify internal and external information sources through an easy to use intuitive interface.

Additionally, in the second quarter we announced that Finegan, a leading intellectual property firm that has been an Interwoven customer for over eight years selected Interwoven universal search. Attorneys at Finegan, will use universe search to securely search, access and use data from multiple internal and external content sources. And the words of Finegan's IT director, sum up well, the effectiveness of our strategy, "Finegan, first selected Interwoven eight years ago and our decision has continually been validated through Interwoven's ability to innovate and enhance their product line to fit the needs of this in increasingly complex industry". Our professional services industry solutions business had a strong quarter. And I am equally pleased with the performance of our web solutions business.

In Q2, the brands that drive the global economy continued to choose Interwoven over a host of competing web content management offerings to help them address their most complex online business challenges.

Let me highlight just a few of our terrific Q2 wins. Rogers communications a diversified broadcasting and publishing company in Canada, chose Interwoven to increase site traffic and advertising revenues by providing, timely, relevant and targeted content that can be managed efficiently across an expanding web presence. Another great example of our success in Europe is our competitive win at [Akley] Unlimited, to replace their existing web content management system. This global bio pharmaceutical company invited Interwoven to the table based on the depth and clarity of our strategic vision and after a thorough competitive evaluation process gave the highest marks to Interwoven's product, service and support capabilities over those of other vendors.

Finally, Belgacom, Belgian's leading telecommunication provider recently, selected Interwoven to replace a patch work collection of web content management platforms, inherited over several years of industry consolidation. Belgacom will be standardizing on Interwoven for a consistent approach to the creation, delivery and optimization of online content. We believe the optimization capabilities we acquired with Optimost in Q4 of 2007, have elevated our position to become an essential component of a company's online marketing strategy.

In the second quarter we saw how this offering provides us with competitive selling advantage as we continue to change the conversation from web infrastructure to online business outcomes. And in the process put our competitors on defense. The appeal of Interwoven Optimost is wide reaching and selective customers subscribing to the service in Q2, included LexisNexis, a division of global publishing giant Reed Elsevier, consumer giant electronics giant Panasonic, Princess Cruises, one of the premier cruise lines in the world and CPS Energy, the largest municipally owned energy company in the US, while our competitors scramble our customers are showing their passion for Interwoven Optimost, by publicly sharing the results they're seeing.

For example, Love Film, Europe's leading online DVD rental and game subscription service, with over 600,000 members, generated a 10% increase in subscription conversions in just four weeks using Interwoven Optimost. The new and existing customers who continue to put Interwoven at the core of their content strategies helped fuel our record revenues in the second quarter.

I want to once again thank and congratulate our worldwide field sales, services and marketing teams along with our alliance partners for another job well done. With a strong first and second quarter completed, we have turned in an impressive performance in the first half of 2008. And looking forward, we have strong momentum and good visibility, which gives us confidence for the second half of the year. Now, let me turn the call over to John who will discuss our financial results in greater detail. John?

John Calonico

Thank you, Max. Before I begin, let me refer you to the financial statements contained in today's press release filed on Form 8-K. This release provides our financial results for the second quarter ended June 30, 2008 as well as a reconciliation of non-GAAP financial information to the comparable GAAP financial measures.

In the second quarter, Interwoven once again posted record revenues and non-GAAP net income continuing the steady financial progress that has occurred over the last several years. For the quarter, total revenues were $63.2 million up 16% from Q2 last year. Of second quarter revenues, 37% was generated from software license fees and 63% was from customer support consulting and training. License revenues in the quarter were $23.4 million an increase of 11% from Q2 last year. For license transactions in Q2, in excess of $50,000, our average deal size was approximately $265,000. In the quarter we had three transactions in excess of $1 million and no single customer accounted for more than 10% of revenues in Q2.

Support and services revenues for Q2 totaled $39.8 million an increase of 18% from last year. To further break down support and services revenues, support revenues totaled $26.7 million an increase of 12% over Q2 last year and consulting, training and software as a service revenues were $13.1 million an increase of 33% from Q2 last year. Clearly our services growth in the quarter was aided by the addition of our multi-variable optimization business. In the quarter, we continued to see the effects of lower consulting services revenues from our global Capital Markets business as customers in that segment continue to tighten spending.

As we look forward to the second half of 2008, we expect there to be a further decline in consulting services revenues from our global Capital Market business as consulting projects come to an end. Non-GAAP gross margin in Q2 was 74%, consistent with last year. Our license gross margin was 95% while our non-GAAP services margin was 63%. Total non-GAAP operating expenses were $35.7 million, up slightly from last quarter due primarily to higher variable selling costs and program expenses.

Our overall head count at quarter end was 922 employees, an increase of 26 employees from last quarter. With those personnel increases occurring mainly in our support, services and development organizations.

Our non-GAAP income from operations was $11.3 million for the second quarter as compared to $7.9 million in the second quarter of 2007, an increase of 43%. As a percentage of revenues, non-GAAP income from operations was 18% an increase from 15% last year. Interest income in the quarter decreased to $1.2 million from $2.3 million in the year ago quarter. The decrease in interest income was primarily due to a lower yield on our investment portfolio. After considering interest and taxes our non-GAAP net income increased by 23% from a year ago.

For the quarter, non-GAAP net income was a single quarter record for us of $8.3 million or $0.18 per share, versus net income of $6.7 million or $0.14 per share last year.

On a GAAP basis our net income for the quarter was $7.5 million or $0.16 per share as compared to net income of $4.2 million or $0.09 per share last year.

For the quarter weighted average shares outstanding were 46.5 million while actual shares outstanding were 45.8 million.

Turning to go the balance sheet, our cash and investments increased $14 million from last quarter to $187 million at June 30, 2008. Cash collections in the quarter were very strong. For the first six months of 2008, we have generated approximately $30 million in free cash flow.

At quarter end, days sales outstanding were 55 days, down slightly from last quarter and in line with our historical range. Deferred revenues, which consist principally of deferred maintenance, decreased to $70 million from $71 million at March 31. This decrease is consistent with our historical Q2 trend, as deferred revenues -- as there are fewer maintenance renewal opportunities in the quarter. Our maintenance renewal rates were in line with historical results.

In summary, Q2 was an excellent quarter for Interwoven. We had record revenues, record non-GAAP net income, our non-GAAP operating income increased by 43% over last year, and our cash flows were solid. And this result positions us well for the second half of 2008.

Before I provide our guidance for the third quarter, I would like to briefly discuss the impact we anticipate from the Discovery Mining acquisition we'll have on our expected results. Discovery Mining operates using a subscription model with revenues recognized over the life of the case or investigation.

Discovery mining has been operating with total revenues between $1 million to $2 million per quarter and at a modest loss on the bottom line. Under purchase accounting principles, Interwoven will be required to write down acquired deferred revenues and contracts in process on the acquisition date which, due to the nature of Discovery Mining's revenue recognition practices, is expected to be in the range of $3.5 million to $4.5 million, reducing Interwoven's recorded revenues by $1 million in Q3 and up to $3.5 million over the next 18 months.

Accordingly we expect the discovery mining revenues in the third quarter will be within a range of $0.5 million to $1 million, with an operating loss in the range of $1 million to $1.5 million depending on the timing of closing. After considering the impact of the Discovery Mining acquisition and factoring in our expectations of reducing spend -- of reduced spending in our global Capital Markets business, we provide the following guidance for the third quarter of 2008.

For Q3, we expect total revenues to be in a range of $63 million to $65 million and we anticipate non-GAAP net income per share to be within a range of $0.15 to $0.17. On a GAAP basis we anticipate net income per share to be within a range of $0.11 to $0.13. These per share estimates are based on a fully diluted share count of approximately 47 million shares.

Now, let me turn the call back to Joe.

Joe Cowan

Thanks, John. As Max mentioned, our clear momentum and strong visibility gives us confidence moving forward into the second half of 2008. Our record financial performance, strong customer traction, and increasing market recognition all validate our strategy which is designed to capitalize on the significant long-term growth opportunities for content management solutions. We will continue to build our brand and reinforce our position as the best of breed solutions provider in our core markets.

We will continue to leverage our leadership and financial strength to capitalize on opportunities that are complimentary to our strategy. And most importantly we will continue to bring innovation to this market and deliver the business impact our customers have come to count on from Interwoven. This concludes our prepared remarks.

Now we would like to open the call for questions. Erica, can you please open the lines?

Question-and-Answer Session

Operator

Certainly. (Operator Instructions). Our first question does come from Derrick Wood with Pacific Growth Equities.

Derrick Wood - Pacific Growth Equities

Hey guys, nice quarter.

Joe Cowan

Thanks you, Derrick.

Derrick Wood - Pacific Growth Equities

What's the timing on when you expect this deal to close?

John Calonico

We expect to close the transaction with Discovery Mining in the third quarter, Derrick. There are some closing conditions associated with the transaction, as are typical, but we expect that the deal will close in the third quarter at this point.

Derrick Wood - Pacific Growth Equities

Okay. And I was just trying to get a sense for what the EPS impact is on the delusion from the deal?

John Calonico

Yes. So, as I mentioned in this script, one of the issues we face with this transaction because they've been so successful with Discovery Mining and bringing in customers, is the fact that we're going to have a fairly significant write down of deferred revenues associated with this transaction and relative to the company's overall revenues -- Discovery Mining's overall revenues. And the result of that is that we're going to end up taking a reduction of about $3.5 million to $4.5 million over the next year to year and a half. In Q3 I expect that the results of incorporating Discovery Mining and after excluding the amounts associated with the deferred write down, that will have an impact of about $0.02 a share.

Derrick Wood - Pacific Growth Equities

And then how long would you expect it to become accretive?

John Calonico

Well, given the deferred revenue write down it looks like we will be looking at a delusion in Q4 of again $0.02 to potentially even $0.03. And then it starts to become -- it starts to progress up as we add additional revenues and then will become accretive in the second or third quarter of next year.

Derrick Wood - Pacific Growth Equities

And so you're not going to give a non-GAAP revenue number that would add back the deferred revenue write down?

John Calonico

What I'll do for you guys is to give you the deferred -- the revenue we would have recognized going forward, okay. And we expect that number in Q3 to be about $1 million, right, the deferred right down.

Derrick Wood - Pacific Growth Equities

And in terms of the comments around the Scrittura Capital Markets business, can you give us some color as to what percentage of revenue that currently is?

John Calonico

Well --

Derrick Wood - Pacific Growth Equities

The actual dollar amount.

John Calonico

The business was about 5% of revenues, Derrick. It's probably down to around 2% of revenues now. And like we said in the prepared remarks. We have seen a fairly precipitous drop off in the consulting services revenues associated with that business. The good news is that the Optimost business has done very well and revenues are growing quite nicely there. And our web solutions and pieces business -- professional services industry solutions businesses have also grown quite nicely and we've been able to offset the effect of that. I do expect there to be a further decline in Q3 and Q4 related to global Capital Markets and those numbers were factored into the guidance we gave for Q3.

Derrick Wood - Pacific Growth Equities

Okay. And on Optimost, any notable trends in cross selling? Are you seeing cross sell in the team side base with the Optimost product and vice versa, the Optimost base with the team side product? And so are you generating most of the deal flow from existing customers or you also seeing new customers?

Max Carnecchia

Hey Derrick, it's Max. So, it does -- I guess the background on that first, kind of, coming back to the prepared remarks, just the ability to tell the comprehensive end to end story with optimization and multi-variable testing, has had just a remarkable impact on the perception of Interwoven in the marketplace with the customers, with the perspective customers, with out partners, we launched a partner program in Q2 with Optimost. So, the effect on revenues and the deals themselves the -- if you want to call it kind of, the free standing Optimost business continues to grow with the team that came over with that acquisition. The majority of the impact as far as revenue is driving Optimost sales into the new revenue, the expansion beyond the team that came over is driving Optimost sales into the Interwoven deals. So, the more traditional behind the firewall licensed transactions adding Optimost into that.

Derrick Wood - Pacific Growth Equities

Okay. And lastly, just, I mean, if you guys can give some more information around the Discovery Mining deal, what their customer count was, what kind of their deal sizes are and really who they compete against.

John Calonico

Sure. Derrick, again, you think about that as more of a software and service business. At the highest levels, you know, the macro factors associated with Discovery Mining and just E-discovery itself are very, very healthy. The history on that market is there's over 750 providers, you know, every mom and pop shop, you know, sir speedy that knew a chief litigator at a law firm was in there trying to provide those kind of services. So, it's definitely right for bringing a more professional business approach to it.

From our perspective the idea of our 1,700 law firm customers the general councils offices where we have this amazing reputation and relationship, that's really the opportunity there. They have currently approximately 100 matters and cases under you know, under management currently. But obviously our play here is to be able to take our distribution channels, take your reputation, take our relationships and work with that first class team that's coming over from Discovery Mining and really amp that up.

Derrick Wood - Pacific Growth Equities

Okay.

Joe Cowan

Hey, Derrick, this is Joe. Let me make another comment on that. One of reasons we really like this company and we've looked at a lot of companies. We believe this is a marketplace that has a lot of growth and the analysts tell us that same thing. But one of the challenges is most companies try to sell into corporations, and that's a very difficult thing because you don't know what's going to happen until there's a suit that hits them. Our approach is to sell into the law firms that we sell to today so that when they get brought into a litigation case they have a standard tool they take in with them. And we believe that's the strategy of Discovery Mining, that's going to be our strategy, we think that is a different strategy in the marketplace and we think it's a very strong approach for us to really come into this place and make some changes.

Derrick Wood - Pacific Growth Equities

So, what kind of tools are used currently inside your customer base then for E-discovery?

John Calonico

The law firms don't typically have long-term established relationships, they tend to have one off ad-hoc things depending on what kind of matter or what kind of legal event is taking place. Again that it can be a series of anything from a small mom and pop to a very established provider out there, but it is just a highly fragmented market where I think we're going to be able to take -- the folks from Discovery Mining are amazing. We're really excited to have them on the team. But, I think that, in combination with our team, our brand, our reputation, the relationships that we have with those existing big firms it's going to be a dynamite combination.

Derrick Wood - Pacific Growth Equities

Okay, I'll get back in the queue, thanks guys.

Joe Cowan

Thanks Derrick.

John Calonico

Thanks.

Operator

Our next question will come from Chad Bennett with Northland Securities.

Chad Bennett - Northland Securities

Good quarter. Couple of more questions on Discovery Mining. Can you talk about the growth rate they were experiencing? I don't know if you want to do last quarter, last 12 months, just based on what I've seen they were kind of doubling their business in recent years. Is that correct?

John Calonico

They're growth rate -- hi Chad, this is John. Their growth rate was very significant over the last several years. And as Max mentioned they've been extremely successful in bringing on new matters. We mentioned in the script, they've worked with over 50 -- or over 50% of the AM Law 200 firms. So, at this point the growth rate has been substantial and as Max mentioned we expect to be able to leverage that with our channel, which, as you know, is very strong in the legal market selling to basically the same buyer. So, yes the growth rate is significant in that business and we expect to continue if not accelerate that.

Chad Bennett - Northland Securities

Is there a way, and I don't want to get ahead of this thing, but kind of ponying up on a question from the prior caller. As we recoup or build back up the deferreds in this business due to accounting issues, you know, if we look out 12 months, you know, can you give us a sense of any type of run rate based on you know, the accounting issues being behind you and that and deferred being built back up and also combining that with a type of growth rate they're experiencing? And then also, you know, in -- other E-discovery firms that I'm aware of, maybe they go about it a little differently, not all of them are sassed models but it's a pretty compelling EBIT margin business compared to even -- really compelling compared to where you're at right now and kind of give me a sense if I'm on the right track there and what we can look out 12 months looking out.

John Calonico

Okay, Chad I don't mean to dodge the question but we've given -- we'll give guidance one quarter at that time. Obviously we bought this business with the idea that we see the same types of margin improvement and types of growth that you are, you are expecting. But at this point you know, we're going to guide out one quarter and we will update that in the next quarter. We clearly are very enthusiastic about this business and maybe Max or Joe wants to step in about the business itself and the differences in selling approach versus other E-discovery firms.

Max Carnecchia

Yes, Chad, I think the only -- this is Max. The only thing I would add to what John has covered here is when you look across the spectrum of traditional providers, they're not really sassed providers, they're outsourcers or they're service providers, where they're throwing bodies at the problem. The team that we have, the team that will be coming over here with Discovery Mining, these guys are some really sharp computer scientists and they have really put into, in essence, an automation process so this thing really does ride on the back of the computing power that they've been able to lay into the algorithm. And I think we're going to have a distinct advantage of being able to deliver a very high level of quality and consistency in the services we provide, while at the same time be able to enjoy the fact that we'll be able to do that against the cost structure that’s worried about more computers and CPU's and bandwidth than number of bodies we have to throw at a problem. So, I think, again, a very unique approach to the problem here.

Joe Cowan

This is Joe. Let me also make some comments. One of the things in this space is a lot of the companies you see out there really provide a lot of manual services. And the key thing, and Max mentioned this, these people have figured out how to automate a lot f that. And the other piece of that, once you get all of this massive number of documents which, in some cases could be hundreds of millions of billions of documents into this massive data base, they don't only have the hardware or infrastructure to be able to manage that large volume of data but they can make, now, that information available to the different offices and the different law firms around the country through the net and they've got very simple and intuitive tools to use, to allow them to mine that data and discover the information that they need. So, these people have that Indian solution which you don't really find any other providers in the market place providing. And they've automated it so they don't have all of the manual steps that a lot of the other people go through.

Chad Bennett - Northland Securities

Okay great. Let me shift real quick to the existing business and these should be pretty straightforward. Can you talk about, I don't know if you did or not, but number of displacements in quarter?

Max Carnecchia

Chad, it's Max. I am assuming you mean on the professional services industry solutions side of the business.

Chad Bennett - Northland Securities

Yes. I am sorry. Yes.

Max Carnecchia

So, we had 14 conversions in the quarter, 12 were from our historical nemesis there, two others that were not.

Chad Bennett - Northland Securities

Okay. Alright. And then just kind of looking at the three large deals, the three seven figure deals you did in the quarter, do you care to say if that was on the web site or the professional services side?

John Calonico

Okay, so the three transactions over $1 million were all on the web solutions side of the business.

Chad Bennett - Northland Securities

And then just lastly, obviously you did three large deals, great quarter from a new customer standpoint. Doesn't seem like you're seeing a lot of macro stuff out there, but was there anything in terms of linearity or anything that you saw in the quarter, maybe vertical markets that were affected at all by what's going on out there?

John Calonico

So, I will address the linearity question, Chad. Our linearity was consistent with what we've seen over the last several years. And Max if you want to address the general macro trend.

Max Carnecchia

Yes, I think it’s similar to what we saw in Q1 Chad, where there's certainly more steps or more scrutiny on each significant investment. Typically we ride along on projects that are not just Interwoven involved. They involve a host of other technologies and hardware that can make these things multimillion-dollar capital expenditures, and I think what we saw in Q1 is what we saw in Q2. If there's another level of rigor and review before these things finally get signed off of on. I think we enjoy the benefit of having a team that's been in the field and been together for you know, eight years. And so, we lived through this in 2002 and 2003 and the idea of really putting strong ROI's together and really pinning down the mechanics of a closing process to insure that you know, we're covered and we're not hit with you know -- an out numbered of surprises. So, that would el be my commentary on Q2.

Chad Bennett - Northland Securities

Okay.

Joe Cowan

Yes, let me also make a comment to you. Factor in, when you think about the business and what's going on, the global Capital Market is weak. There's a lot of problems there. If you remember John told you that as a percent of overall revenues, that business first dropped from about 5% to the 2% to 3%. So, think of our performance in light of that one segment where that occurs. So, that can show you how strong our other businesses are, folks. And I think that's a test to the fact that we're very focused company. We have a very good strategy. Our customers really know who we are, where we're going, and we've identified, I think, the right markets and know how to approach those markets where our business is looking well.

Chad Bennett - Northland Securities

Okay. Last question and then I will jump off. Any change competitively you saw out there?

Max Carnecchia

Chad, it's Max, the competitive landscape remains about the same. The only -- I guess the only thing I would comment on, which I think we've said in the past, past but I would just re-emphasize now, some of these bigger strategic stack vendors, IBMs, the EMC, the Oracles, you know, the guys who have account control -- Oracle went through the end of their year -- their fiscal year end the end of May. And you know, these guys lean on customers and exploit those relationships and try to roll their stuff up with the ELA's. I can just tell you from our -- now going back all the way to when Documentum was bought by EMC, ultimately those turn into opportunities for us. They don't involve the customers problem. They roll up on the CIO they get it built into ELA, but we're dealing with business folks who have distinct business pain and we have a unique differentiates answer to that. And we turn those things into -- long term we turn those things into opportunity for Interwoven.

Chad Bennett - Northland Securities

Okay, thanks, guys. Good job.

Operator

(Operator Instructions). Next we'll move to Mark Schappel with Benchmark Company.

Mark Schappel - Benchmark Company

Hi, good evening, nice job.

Joe Cowan

Thanks.

Mark Schappel - Benchmark Company

Nice job on the deal as well. John, a question for you first off. R&D seemed to tick down a little bit this quarter and I was wondering if I should read into that or if it's just kind of a one-time blip?

John Calonico

I wouldn't read anything into it, Mark. I think it's just kind of a timing of sub-contract labor. I would expect R&D to continue to remain roughly the same percentage it's been going forward.

Mark Schappel - Benchmark Company

Okay. And I also didn't catch the international domestic mix. Do you have that handy as far as a percentage of sales?

John Calonico

It is essentially 0.6 in the US and 0.3 internationally. The mix remains very much the same as it has been.

Mark Schappel - Benchmark Company

Okay. And then Max on the three large deals, going back to those. I was wondering if you could just give us a sense of who you were competing against with those?

Max Carnecchia

Well, let me just kind of play it through in my head. One is a great example against one was an international deal where it was a great example against and Oracle shop. So, you know, the bit there. The other two were the usual suspects. The other two, kind of the usual suspects, you know I didn't cover this off with Chad when he asked the competitive question. But I think the landscape is changing in the sense that if you point to the recent Gartner market scope report issued about two weeks ago, I think that the work that we've done to differentiate ourselves and really deliver solutions for interactive marketers, is absolutely being recognized in that report.

Mark Schappel - Benchmark Company

Okay. And then kind of on that, that theme I was wondering if you could just address what you are seeing in the marketplace with respect to some of the smaller mostly private guys out there and the web content space. You know, whether they're getting any traction with customers, are they, you know, being invited to some of these bake-offs?

Max Carnecchia

Remember that the historical sweet spot for Interwoven is the tip of the pyramid, the biggest companies with the hardest problems and we command a premium there. When you get into, what I would call departmental areas within those companies or you know, the more medium sized businesses under a billion dollars, we typically do see those folks and again depending on what that organization is trying to go achieve and where their pain points are, you know, we either want to play and win or we elect that we're not the right solution and we typically bow out. So, I don't know how competitive that gets only because I think most of us are getting pretty disciplined around where we want to spend our resources and where we really want to have a sword fight. If its not a perfect match, if its not a good solid match, we're typically not there together.

Mark Schappel - Benchmark Company

Okay. Thank you. That's all for me.

Max Carnecchia

Thanks, Mark.

Operator

And next we'll hear from Barbara Coffey with Kaufman Brokerage.

Barbara Coffey - Kaufman Brokerage

A couple of quick questions. As you know, obviously these results there's some that you are not seeing economic weakness, but are you seeing any sort of change in the sales cycle whether not it's the legal side or on the web side? Also, what is kind of the overlap between the E-discovery and your own legal markets and is this, you know, is there bias towards law firms or is this also being used in corporate environments?

John Calonico

Sure. So, let me-- the first part of that question was around change in sales, sales motions or sale cycles, I don't think anything more than I've already touched on Barbara. The idea that there's more scrutiny and maybe a couple of more places where things have to be signed off.

On the legal market, you know there's -- I think there's been a lot of publicity or press around you know how M&A has slowed down and obviously financial services is typically a pretty big feeding ground for the larger law firms. What they're doing with their summer interns, what they're doing with laterals. I mean, we haven't seen that slow down so much as we've just heard a lot of caution as far as continued rapid growth in the fight -- for the battle for that talent. So, I think we continue to see that being solid with a weather eye if you will. An eye on the horizon to see what's really going on there over time.

The E-discovery and legal markets, I don't know if I completely am parsing your question. I'll try to answer it and if I miss the mark you can rephrase it. But, law firms are typically where corporations and general councils are turning to get E-discovery services, they're being sourced by the litigators that they're turning to, to work on these matters, to work on these lawsuits.

So, that's typically the first place to turn. There has been a trend over the last two or three years where large corporations that are typically part of serial litigations or under a lot of litigation, you know, just subject to a lot of litigation in the pharmaceutical companies, the three M's the duponts of the world have started to try to grab hold of some of this themselves because it is such a large line item. And when you're spend $10 or $15 million a year on E-discovery you probably want to put a little more control around it than just being at the mercy of who every your outside council is. Joe, anything to add to that?

Joe Cowan

No. I would just -- I mean, if you look at the space in terms of how it's set up, you know, the corporations -- when the vendors are trying to sell to them and even when they're buying, I mean it's based upon how many lawsuits you've got or when you have a lawsuit. It's a very jagged curve up and down. And the beauty of this process is going into the litigation departments and establishing a relationship with them. You know, they continuously are being brought into cases. And in some cases maybe we're not getting the biggest lawsuits, but we're down a level and I think it is there's a quantity out there, which makes the business much smoother and we like model much better than just trying to go in sell big cases to corporations.

Barbara Coffey - Kaufman Brokerage

Okay. Thank you, guys.

John Calonico

Thanks, Barbara.

Max Carnecchia

Thanks, Barbara.

Operator

Next we'll move to Brian Murphy with Sidoti and Company.

Brian Murphy - Sidoti and Company

Hi, thanks for taking my questions, most have been answered. Just a couple, Max, you may have already answered this the new customer wins -- are most of those coming on the web site?

Max Carnecchia

I think it's a consistent distribution between what we've seen historically between the web and what we've seen on the pieces side.

Brian Murphy - Sidoti and Company

Okay and you know, with this new acquisition, how is this going to work in terms of selling this thing? Are your channel partners going to be involved here or is this more of a direct sale?

Max Carnecchia

So, the because it is a sass model we believe that initially it will be a direct -- it will be -- continue to be a direct offering. There's a team of under ten folks on the sales side that will be coming over from Discovery Mining and obviously we'll match them up very closely with our team in the field. Over time though, although sass typically doesn't lend itself -- a sass model typically doesn't lend itself to a channel play, because of the nature of what happens in E-discovery, there are a lot of surrounding services that can typically go around that that require on premise work whether that's investigatory work, whether that’s actually the downloading of material on to a hard drive. We think that there are some things that we will be able to turn to our long established and strong channel to be able to help with. So, you know, it's too early to really kind of articulate that and roll it out but that's something at work on that right now.

Joe Cowan

And if you actually go back and look at the Optimost business, you know, as Max mentioned, in Q2 we actually came out with a program to involve our partners in that business. So, you know, that's something that I think we've a good appreciation of how to work with partners and I think that will fall into a natural place as we go forward.

Brian Murphy - Sidoti and Company

Okay. Thanks. And just a quick housekeeping question for you, John. How should we be thinking about the tax rate going forward?

John Calonico

Well we'll continue to use on the non-GAAP numbers, a 34% rate and on the GAAP numbers, we'll -- we're using a 10% rate.

Brian Murphy - Sidoti and Company

Okay. Thanks very much.

John Calonico

Very good.

Max Carnecchia

Thanks, Brian.

Operator

(Operator Instructions). We'll hear next from Nate Swanson with Bank Equity.

Nate Swanson - Bank Equity

Hey, guys.

John Calonico

Hi, Nate.

Joe Cowan

Hi, Nate.

Nate Swanson - Bank Equity

I am not as familiar with the business models behind E-discovery space. Can you walk us through the pricing and contract terms? It sounds like this is a case-by-case sales model.

Max Carnecchia

Yes. So, Nate it's Max. Typically what happens is you know, you're working with one of these firms that are representing the litigation for a large corporation, they're on one side of the matter or the other. And the economic model around this is typically a one off, [hide] to the matter itself. You know, the average duration of a matter can be, you know, in years, I mean just think [Exon Valdese]. That things been going on for, you know, decades now. Maybe that's not typical, but they typically are multi-year type matters.

The way these things typically charge, there's typically a charge for the initial loading of the data itself, the conversion of the data into, you know, a hosted environment where they charge on a per gigabyte basis. And then there's an on going hosting charge, that allows the customer to have access and to use all of the tools to do the discovery itself. Now, depending on who the vendor is, again, outside of Discovery Mining, there can be all kinds of ups and outs and extras for generating TIF files, for doing special loads for special cuts, but just to give you a good idea of -- or a broad idea of how the industry, you know, comports itself today. That's probably, at a high level, the best way to go.

Joe Cowan

Yes. One of the challenges in the industry today is the -- I guess I would say the non-predictable cost of a lot of the matters and that's something that we heard a lot of complaints about and that’s something that Discovery Mining has a more predictable model that all of the firms they sell to in there -- those firms and clients, really like their pricing models and their predictability much, much better.

Nate Swanson - Bank Equity

Okay. So, how much of their revenue is recurring, I guess, is my question?

John Calonico

Well, the majority of that revenue is recurring. You have these up front load charges which just because of the nature of the company that we are, you know, those will be, those will be taken over in some sort of --

Max Carnecchia

Recorded over the life of the matter, Nate.

Nate Swanson - Bank Equity

Okay.

John Calonico

And so essentially what we will not do is we will not have any one-time revenue events within that business because of the nature of the matter and the integration of the services and our accounting election. What we will do is recognize all of those fees over the life of the matter and as Max mentioned the life of those matters can be upwards of years. So, clearly that will help us be a little smoother in the way that revenue gets recognized.

Nate Swanson - Bank Equity

Okay. That's very helpful. And then I guess how do you think about up selling or repeat business within their existing installed base?

Max Carnecchia

I think to John's point, one of the biggest things we heard in, you know, we've been looking at this space, obviously with our footprint with law firms and the great team we have in the professional services area, we've been looking at this space for over two years. And that investigation and the hypothesis testing we've done there comes back over and over again to litigation support folks within large law firms need quality and they need consistency. That's what they're looking for.

So, when you think about being able to up sale or being able to go into a large firm that has 17 offices around the country, our ability to up sale them or to be able to turn that into repeat business, I think just through that brand and the relationships we have, combined with the amazing service levels and the consistent delivery of that service through this unique sass model from Discovery Mining turns into the combination that Joe was talking about that’s just -- I think it's just a very unique winning combination.

Nate Swanson - Bank Equity

Yes. Okay. Alright. That's all I had. Thanks.

Max Carnecchia

Thank you, Nate.

John Calonico

Thanks, Nate.

Operator

And we have no further questions in the queue. I would like to turn the conference back over to Ms. Ackerman for additional or closing remark.

Keren Ackerman

Thanks everyone for joining us today. We look forward to talking to go you again in October. Let me turn the call back to Erica.

Operator

That does conclude today's conference. We do thank you for your participation. Have a great day.

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Source: Interwoven, Inc., Q2 2008 Earnings Call Transcript
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