Double-Take Software, Inc. Q2 2008 Earnings Call Transcript

Double-Take Software, Inc. (DBTK)

Q2 2008 Earnings Call Transcript

July 29, 2008 4:30 pm ET

Executives

Erica Mannion – IR, Sapphire Investor Relations LLC

Dean Goodermote – President, CEO and Chairman

Craig Huke – CFO

Analysts

Jonathan Ruykhaver – ThinkPanmure

Tim Klasell – Thomas Weisel Partners

Aaron Schwartz – JPMorgan

Brent Bracelin – Pacific Crest Securities

Sean Hannan – Needham & Co.

Mark Kelleher – Canaccord Adams

Manish Hemrajani – Oppenheimer & Co.

Walter Pritchard – Cowen & Co.

Presentation

Operator

Welcome to Double-Take Software's earnings conference call for the second quarter 2008. The date of the call is July 29. The call is property of Double-Take Software and any recording, reproduction or transmission of this conference call without any express written consent from Double-Take Software is strictly prohibited. This call is being recorded. You may listen to the webcast replay of this call by going to the ‘Investor Relations section’ of Double-Take's website.

I would now like to turn the conference over to Erica Mannion, Investor Relations for Double-Take.

Erica Mannion

Thank you. Good afternoon and thank you for joining us to discuss Double-Take's financial and operating results. With me today are Dean Goodermote, President, CEO and Chairman of the Board of Directors and Craig Huke, Chief Financial Officer.

On the call today you will hear forward-looking statements about events and circumstances that have not yet occurred. Statements regarding projected financial results, statements containing words such as will, expect, believe and should and other statements in the future tense are forward-looking statements. Actual outcomes and results may differ materially from the expectations contained in these statements due to a number of risks and uncertainties. Please refer to the Company's recent SEC filings at the SEC's website at www.sec.gov for detailed discussions of the relevant risks and uncertainties. The Company undertakes no responsibility to update this information in this conference call under any circumstance. The press release distributed today that announced the Company's results is available on our website at www.doubletake.com in the ‘Investor Relations’ section under ‘Financial Press Releases’. The current report on Form 8-K furnished with respect to our press release is available on our website in the ‘Investor Relations’ section under SEC filings.

In addition, in this conference call we will provide non-GAAP financial results. The reconciliation of these measures to GAAP measures is set forth in the tables that reconcile our non-GAAP results to GAAP results from the press release located on our website as I just described. Before I turn the call over to Dean, I would like to mention that the Company will present at the following investment banking conferences during the calendar quarter. Pacific Crest Technology Leadership Forum on August 5th in Vail, Colorado and Canaccord Adams Annual Growth Conference on August 12th.

Now, I would like to turn the call over to Dean Goodermote, Chairman, CEO and President. Dean?

Dean Goodermote

Thanks, Erica, and thank you all for joining our call. We're pleased with the results for the quarter. We generally try to keep our guidance in narrow ranges. In this case we hit the lower end of the revenue guidance rather than the higher end almost entirely due to receiving less than expected license sales out of Europe. Otherwise, business was as good as we expected. We are prudent in expenditures in general and in bringing on new hires specifically. By controlling the expenses we have maintained what I think are very good earnings. Craig will provide you with more detail on the financials and I will provide more color on Europe later in my remarks.

As you know, our sales SKUs that we track did not account for all our sales on Virtual Systems. So, they are not exact statement of our position in that market and tend to understate that position. With that said we believe we continue to do well in this market. Measurable Virtual Systems sales were up 63% over the second quarter last year and represented more than 11% of total product sales. Of particular note is Double-Take for VMware Infrastructure, which replicates between VMware's ESX guests. Those small dollars is growing extremely rapidly.

We believe our virtual market position will be enhanced further as Microsoft grows its Hyper-V offering. In June, we announced multiple offerings supporting Hyper-V, which were well received. We expect some Hyper-V related orders this quarter though that we anticipate Hyper-V will ramp up over time.

We also announced the release of Virtual Recovery Assistant last quarter which simplifies both the process of migrating to VMware ESX virtual machines as well as helping users better leverage virtual machines for high availability and disaster recovery and physical workloads.

All in all it was a good virtual systems quarter for us in terms of product sales, marketing and product delivery. By the way, the virtual recovery system I just mentioned was delivered as an add-on to core Double-Take at no extra charge. Those of you who have been following us know that we do this to boost recurring maintenance revenue and to some degree it comes at the expense of foregone license sales. And we've been very successful in boosting revenue from maintenance fees. Once again this quarter showed strong gains here.

Our Linux launch secured its first revenue significance last quarter, though we have still not formally launched it. We now have some accounts to leverage more sales. As I've often noted our expectations are modest in this area because the typical drivers for our current products such as email are not significant. However, we will continue to look for themes that will drive demand and in the long run this platform we may need to be on as the Company grows.

Many of our metrics remain the same as in previous quarters. Our three tier distribution model has shown little change. About 88% of our sales were indirect. Dell and Sunbelt were about – 10% plus resellers and Tech Data is moving up, though not above 10% yet. Dell had a record quarter and contributed to 17.5% of our business.

Our average and median deal sizes are the same as last quarter, 11,000 and 6,000 respectively. As you know, we have not been happy with the performance of our HP channel and I've considered abandoning it. The major accomplishment this past quarter was that we gained support at the VP level from HP. It is too soon to tell if this support will generate sales, but we are hopeful that the new attention and focus will improve business. HP related business was on par with Q2 last year, just above 4% of our total and above where it was in Q1 of this year.

Though it does fluctuate, one metric that changed from last quarter was our mix of international business, which was down from about 40% in Q1 to about 36% in Q2. Our performance was weaker than expected in Europe probably because of both market based conditions and internal factors. Market wise, the virtualization noise and its promise to solve many IT problems including disaster recovery and high availability was louder in Europe and our ability to generate our complementary message to end users through a myriad of partners and a myriad of languages was weaker than in North America. IT buyers in many cases were buying serially, getting their virtualization house in order before following up with disaster recovery. To some extent this frenzy appears to be subsiding, but in addition we're working more closely with VMware in Europe than we were and we're signing up important VMware distributors to make sure our virtualization benefits get through to the end users.

Internally, we believe we needed to and are now doing more effective web-based local language lead generation and we also have reorganized the sales effort in the U.K. We are also attempting to leverage HP more in Europe where it is relatively strong. We expect these changes and others to improve results in Europe though they may not show immediately.

We continue to set the stage for the future to be a broader infrastructure place, specifically in an area we called dynamic infrastructure. As you read in the press release we sent out today we acquired emBoot, a small Toronto-based company that has expertise and products in the network booting space. As we've discussed previously, we look to make small technical tuck-in acquisitions that will advance our position in the marketplace. The ideal company is one that has excellent engineering talent with product that has not yet broadly distributed. EmBoot is such a company. With the technology and expertise we acquired here we will be able to dynamically move systems, leveraging both the host based technologies we have developed in the storage space, Internet Small Computer Storage Interface Software Technologies, or ISCSI technologies that emBoot has developed.

IT professionals will now be able to launch new systems, physical or virtual, faster and more cost effectively. They also may be able to save on power and hardware costs by reducing systems requirements. Let me illustrate a little more. Using an ISCSI-compliant storage solution, Double-Take customers will now be able to create bootable images of their production workloads and use a centralized workload management console to assign those workloads to any available physical or virtual machine in their environment. Optionally, companies will be able to build a software based ISCSI Storage Area Network, or a SAN, using standard server hardware and storage using – included ISCSI target software.

IT professionals will be able to quickly create an IT SAN in minutes using commodity server hardware and discs they may already have. The ISCSI based network booting features will make it easy to migrate workloads to new hardware to virtual machines or back based on changing demands. Craig will speak more to some of the financial details on the emBoot acquisition.

In summary, we had a strong earnings quarter and our revenues were within the guidance range. We are taking steps to address the issues we have with license sales in Europe. We're optimistic about our position in the market and we believe that we will still achieve our previously stated revenue guidance for the year even if you exclude the contribution of emBoot we will be making. We also believe that we are setting the stage for longer term growth with small technical tuck-in acquisitions such as emBoot.

With that, I'll turn it over to Craig.

Craig Huke

Thanks, Dean. Good afternoon, everybody and thanks for joining us. Our second quarter was a good quarter even though revenue was at the low end of our stated guidance. Non-GAAP operating income was above our guidance and diluted earnings per share were at the high end of the range. Our Q2 balance sheet finished strong with approximately $74 million in cash and cash equivalents at June 30th and sequential deferred revenue growth of almost 4%.

Looking at some of the specifics of the quarter now, Double-Take's total revenue for the second quarter was $24.4 million, an increase of 21.9% from $20 million in the second quarter of 2007. Software license revenue was $13.6 million, an increase of 13.6% from second quarter of 2007. Maintenance and professional services revenue totaled $10.8 million for an increase of 34.4% from the second quarter of 2007.

As Dean mentioned in his remarks, license sales in Europe were less than we had hoped for at the beginning of the quarter, but license sales in North America and Asia came in pretty much as we had expected. Revenue from TimeData was approximately $50,000 in the quarter. This is consistent with our expectation at the time we acquired the company and we hadn't expected meaningful sales from the TimeSpring acquisition to occur until the second half of the year.

Our resellers generated 69.4% of total sales, distributors generated 13.9% and our OEMs generated 4.9% of total sales. Overall, our indirect channels generated 88.2% of sales. As we've said in the past these percentages will vary from quarter to quarter, though probably not significantly within any couple of quarters. OEM sales, which are primarily from Hewlett-Packard, increased to almost 5% of sales in the second quarter from 3% in Q1 of 2008. So, revenue generated from HP did bounce back a little bit from the Q1 levels, however, year-to-date revenue from HP is still down compared to 2007.

Gross margin for the quarter was 89.2% compared to 89.3% last quarter and 89.4% in Q2 of 2007. Excluding stock option expense, the gross margin was 89.6% in both Q2 of 2008 and 2007. Our gross margin percentage is typically lowest in the first half of the year, but we anticipate the gross margin will be approximately 90% in each of the last two quarters of 2008.

Total operating expenses were $17.4 million, an increase of 24.8% compared to the second quarter of 2007. Excluding stock option expense operating expense increased 21.6% to $16.4 million from the second quarter of 2007. Sales and marketing expense increased 29.7% to $8.9 million in the second quarter of 2008. Excluding stock option expense, sales and marketing expense increased by 28% to $8.6 million. The increase resulted from higher commission cost on higher sales, costs from higher headcount in both the United States and Asia, as well as increased marketing costs and certain reallocation of resources in Europe for individuals who now have direct responsibility for sales function. Excluding stock option expense, sales and marketing expense was 35.4% of revenue in the second quarter of 2008 compared to 33.7% in the second quarter of 2007.

Research and development expenses increased 45.4% to $4.1 million in the second quarter compared to 2007. Excluding stock option expenses R&D increased by 38.7% to $3.8 million. The increase is due primarily to increased headcount, increased third-party cost used to supplement in-house development activity and expenses associated with Double-Take Canada, which was acquired at the end of 2007. The expenses associated with Double-Take Canada were about $600,000 during the quarter. Excluding stock option expense, R&D as a percent of revenue was 15.7% in the second quarter of 2008 compared to 13.8% in the second quarter of 2007.

General and administrative expenses increased 5% to $3.5 million. Excluding stock option expense, G&A expense was $3 million compared to $3.4 million in Q2 of 2007. The decrease is due to reduced bad debt provisions, decreased public company costs in the quarter compared to Q2 of 2007, and reallocation of certain resources in Europe from G&A to sales and marketing. G&A as a percent of revenue was 12.5% in the second quarter of 2008 compared to 17.1% in 2007.

Depreciation and amortization expense increased 55% to $900,000 in the quarter. The increase is due to depreciation on capital expenditures made over the past year and amortization on the technology related intangible from our acquisition of Double-Take Canada, which was $100,000. Of that $900,000 of depreciation and amortization in the quarter $300,000 was related to the amortization of intangible assets associated with acquisitions.

GAAP operating income for the second quarter was $4.4 million compared to $4.0 million in the second quarter of 2007, an increase of 10.9%. GAAP operating margin was 18% compared to 19.8% in the same quarter last year.

On an adjusted non-GAAP basis, operating income was $5.5 million in the second quarter compared to $4.4 million in the second quarter of 2007 for an increase of 23.1% and above the top end of our previously stated guidance for the quarter of $5.2 million to $5.4 million. Non-GAAP operating margin for the second quarter increased to 22.4% from 22.2% in the second quarter of last year.

A reconciliation of these non-GAAP financial measures as well as other non-GAAP financial measures referred to in this call to the most directly comparable GAAP financial measures is included in the appendix to our press release that preceded this call and is available on our website. We also include in that release an explanation of how we use the non-GAAP measures and the components of these measures and we urge you to carefully read those disclosures.

Turning now to other income, investment income decreased by $300,000 to $470,000 in Q2 of 2008. The decrease resulted from lower returns on our cash and short-term investments, which were maturing during the first half of 2008 and then reinvested at lower rates during the quarter.

In Q2 we also incurred foreign currency exchange losses of about $40,000. The exchange loss is significantly lower than the $345,000 loss we experienced in the first quarter as the U.K. pound stayed relatively steady against the euro. Because a significant part of our EMEA operations are denominated in U.K. pounds we incur losses if the pound weakens against the euro; if the pound strengthens against the euro we record gains.

GAAP net income was $2.7 million or $0.11 per fully diluted share for the second quarter of 2008 compared to GAAP net income of $7.5 million or $0.33 in the same period a year ago. The decrease in net income and earnings per share is due primarily to income tax expense and increased stock option expense.

During the second quarter of 2008 the Company recorded an income tax expense of $2.2 million compared to an income tax benefit of $2.8 million in the second quarter of last year. Income tax expenses increased due to increased taxable income in the current year and the fact that in 2007 taxable income was offset by a reduction of the valuation allowance of deferred tax assets. Had the income tax rate in Q2 of '08 been in effect in Q2 of '07 diluted earnings per share would have been reduced by $0.22 to $0.11 per share. Our effective income tax rate on GAAP income was 44.8% in the second quarter and this rate continues to be affected significantly by the year-over-year increase in stock options.

For the second quarter adjusted non-GAAP net income was $3.7 million or $0.16 per diluted share compared to $8 million or $0.35 per diluted share in the second quarter of 2007. Once again, the lower net income is primarily related to higher income taxes in '08 compared to 2007. Had the income tax rate in 2008 been in effect in 2007 non-GAAP diluted earnings per share would have been reduced by $0.21 a share to $0.14. The effective tax rate on non-GAAP income in the quarter was approximately 36.6%. And to get to non-GAAP net income we exclude only non-cash stock based compensation expense associated with stock options of $1.1 million in 2008 and $500,000 in Q2 of 2007.

We ended the quarter with cash and short-term investments of $73.8 million compared to $69.8 million at March 31st, 2008, and $64.7 million at December 31st, 2007. Cash from operations during the second quarter provided $5.2 million and we used $1.3 million for capital expenditures.

Accounts receivable at June 30th was $18.1 million, which is up from $16 million at March 31st, 2008. Accounts receivable days sales outstanding was 67 days at June 30th compared to 63 days on March 31st and 69 days on December 31st, 2007. This number has moved around a bit from quarter to quarter and can be influenced by the timing of renewals, maintenance renewals, which are recorded in deferred revenue, and collections near and around the end of the quarter. While the DSOs did increase a little bit in the quarter it's still in the range that we've seen over the past year. Headcount for the Company was 382 at the end of the second quarter compared to 368 on March 31st, 2008.

Now, I'll go through the financial guidance for Q3 2008 and the full year. And keep in mind, this guidance does include the expected operating results of our emBoot acquisition, which was announced this afternoon. By way of background, emBoot is located near Toronto, Canada and has five employees, including the founders of the Company, all of whom will become employees of Double-Take Canada. Historically, emBoot has generated annual revenues of less than $500,000 a year and operated at roughly break-even levels. As part of the acquisition, we've put into place a retention bonus plan in an effort to keep the key developers with Double-Take and we've also estimated there will be approximately $2.5 million of identified intangible assets that will be amortized over five years. That number can change as we complete the final accounting for the acquisition.

The Company expects revenue for the third quarter of 2008 to be in the range of $25.7 to $26.3 million. Non-GAAP operating income excluding the impact of stock option expense will be in the range of $5.3 million to $5.5 million. Keep in mind that non-GAAP operating income does and always has included the effect of the amortization of intangible assets, which will be approximately $400,000 in the third quarter.

Non-GAAP income per share for the second quarter is expected to be in the range of $0.15 to $0.16 per share. The effective income tax rate on non-GAAP income is expected to be approximately 37% and average diluted shares approximately 23.2 to 23.3 million shares. As we indicated in the earnings release, the emBoot acquisition is expected to decrease non-GAAP operating income by approximately $300,000 and non-GAAP net income per share by $0.01 in the third quarter from where they would have been without the acquisition.

Incremental revenue from emBoot is expected to be less than $100,000 during the third quarter. And also included in these numbers are approximately $100,000 for retention bonus and $100,000 for amortization of identified intangible assets with the acquisition.

For the full year we are leaving our revenue guidance unchanged at $101.7 to $103.5 million. This does include revenues expected from the emBoot acquisition of less than $400,000. Excluding emBoot, full-year revenue might come in closer to the low end of our guidance range since we've just completed a quarter where we did not contribute to the upper end of the full year guidance.

Full-year non-GAAP operating income is expected to be $21.8 to $22.2 million, which is down from previous guidance of $22.2 to $23.0 million. The reduction in expected non-GAAP operating income is due solely to the effect of the emBoot acquisition, including the retention bonuses and amortization of intangible assets of approximately $700,000 to $800,000.

Adjusted non-GAAP income per share for the full year is expected to be in the range of $0.63 to $0.65 per share, down from previous guidance of $0.65 to $0.67, once again solely due to the effect of the emBoot acquisition on earnings of approximately $0.02 for the second half of the year. We expect emBoot to be accretive from what would be otherwise our performance in 2009.

The effective tax rate on non-GAAP pre-tax income is anticipated to be approximately 37% and weighted average diluted shares are assumed to be approximately 23.3 to 23.4 million. As I said in last quarter's call, our estimated effective tax rate of 37% for 2008 on non-GAAP basis is significantly higher than what we will incur on a cash basis. Taking NOL carry-forwards and other potentially available credits into account, our cash tax rate for 2008 will be approximately 20% to 25% of non-GAAP pre-tax income.

So, once again thanks everybody for joining us today and we will now open up the call for questions. Operator?

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Our first question comes from Jonathan Ruykhaver from ThinkPanmure. Your line is open.

Jonathan Ruykhaver – ThinkPanmure

Hey, guys. Congrats on the quarter. Hey, Dean, I didn't quite understand your explanation around weakness in Europe. I think you suggested it was somewhat market, maybe execution, and you also said that virtualization issues may have impacted the overflow. Can you just elaborate a little bit? I might have misunderstood that explanation.

Dean Goodermote

Probably not. Sorry. I'll try to be clearer. I mean one never knows specifically things, but I'd say you characterized it right, market and then some internal issues. Markets specifically is that virtualization has come on strong there maybe even stronger and we're a little more separated from our – the end users there because we rely on our channel like we do here, but even more so because of the different languages and geographies. And the virtualization message went out, particularly the VMware basically saying this does everything, in our case disaster recovery, high availability. Well, it does as long as it's complemented with something; a system like ours or SAN or something. And so in Europe there appeared to be a lot of frenzied and serial buying, so there were a lot purchases using up IT budgets for the virtualization purchases and holding off on what would be our complementary purchases.

Jonathan Ruykhaver – ThinkPanmure

Right.

Dean Goodermote

And so it was noisy and I think slowed sales or our people there think slowed sales from what otherwise would have happened. Does that make sense?

Jonathan Ruykhaver – ThinkPanmure

Yes, I guess it does. So, I guess the assumption that you had entering the quarter was that there would be more revenues directly influenced by virtualization in Europe, but what about the other core business, (inaudible) exchange?

Dean Goodermote

Well, no, no I think it was – it's both. One would be some out of virtualization and just some that these companies were buying virtual systems and not doing anything else or at least that's the way it appeared to us. So, it's affecting even their physical buying patterns; deals that our guys thought they would otherwise get. This sort of lopped off the top end of really where we would like to be. And now we – we never know specifically where we will be, but we'd like to hit the top end and it effectively sort of took off really towards the end of the quarter, this chunk of revenue that would have put it right at the top. And it's because these guys thought that the deals were coming in and they didn't.

Jonathan Ruykhaver – ThinkPanmure

So, just to clarify that. It wasn't due to any kind of macro pressures, it's just more handholding with the channel and making sure the issues on the part of the customer are addressed properly?

Dean Goodermote

I think the economy is particularly bad in the U.K. and we mentioned this last quarter. And the UK has specifically said that they have "deals slip" because of that. And I just spent two and a half weeks myself in Europe and I can tell you that the press there has gone beyond the U.K. to Spain is in trouble and it's slipping into other places. Even the German markets are starting to have a little malaise.

Jonathan Ruykhaver – ThinkPanmure

Okay.

Dean Goodermote

But this is bad economy stuff. This is the world we're in right now. It’s been going on for a while, so I think we have to kind of look at – get our outlook together and think of meeting our numbers with that factored in.

Jonathan Ruykhaver – ThinkPanmure

So, in terms of your guidance – because it looks like the guidance for September is pretty much in line with what the market was expecting. Are you incorporating the same type of environment in Europe as you look to that guidance? You're not expecting any kind of improvement.

Dean Goodermote

Yes, I think so. The world is not – I really feel like our business would be much, much better if the economies were doing well and they're worse if they are not. I wish they were doing well, but we feel like we're in this world of a – of the downturn right now.

Jonathan Ruykhaver – ThinkPanmure

Right. Okay. And just last question on Dell–

Dean Goodermote

I'm sorry; specifically, there were internal issues, too. We had organizational and management issues in the U.K., which we feel we've addressed and some other types of clean up like that, which we investigated and feel that we've fixed.

Jonathan Ruykhaver – ThinkPanmure

Okay. And then just one last question on Dell. Dell seemed to be pretty strong in the quarter. Can you comment on that strength? And is Dell selling mainly just in North America?

Dean Goodermote

It is now, but that's an important point is that we're sort of changing that relationship. Dell has typically not been as strong outside of this country and I think that's true with them and a lot of their partners. And we're now restructuring our relationship so we can leverage them abroad, too. We're starting to see some of that, too. So, it should start to see some pickup outside of the country. Today it's mostly in the U.S. But we have a really good relationship with them in a lot of ways.

Jonathan Ruykhaver – ThinkPanmure

Okay. I'll drop off. Thanks, guys.

Dean Goodermote

Thank you.

Operator

Thank you, sir. Our next question comes from Tim Klasell from Thomas Weisel Partners. Your line is open.

Tim Klasell – Thomas Weisel Partners

Yeah, good afternoon everybody. A quick question on the emBoot acquisition. Can you sort of walk us through what product sets – how they will be priced, how you plan on bringing them to market? And is this product sold to the same type of customer that would by the traditional Double-Take products?

Dean Goodermote

There are some customers that – they have a bit of an embedded market and we may – and an OEM market and that's still – we're not planning on stopping that. And maybe that becomes a growth area. But other than that, we look to take this to the same marketplace that we're in today and the products specifically that we'll expand upon are really threefold. You have a management console, which we probably will price – and this has not been announced – but we'll probably price around the $4,000 range. And then a server and agent around the – target agent around the $400 range, and then a desktop agent around $100.

Tim Klasell – Thomas Weisel Partners

Okay. And who–?

Dean Goodermote

And so where you may well see the benefit of this is not so much reporting on an individual sales like this as much as it will be that we can go into an environment and if there are ISCSI SANs there we can use them to leverage that environment. As you know, we're host based versus storage based, now we can be both. Or they may create an ISCSI SAN environment. This is software, so it will look like it is an ISCSI environment. And we will presumably sell lots to Double-Take. So, there may be a minimal amount of emBoot involved in substantial Double-Take business.

Tim Klasell – Thomas Weisel Partners

Okay. Very good. And on the OEM relationships, how much of the $500,000 annual run rate comes from the embedded space versus the direct sale?

Dean Goodermote

I don't have a direct exact number. It wasn't the majority or something like that.

Tim Klasell – Thomas Weisel Partners

Okay. Very good. And then just jumping back over to Europe, was there any particular products that were a little bit weaker or was it just sort of – was it more of a geo-type of a slowdown? Sort of all products in certain geos?

Dean Goodermote

I'd say all, but despite our virtual success when I looked at the numbers, they were – those are Virtual Systems and the Virtual for ESX replication was not – it grew well, but not to the explosive growth that we have here in the U.S.

Tim Klasell – Thomas Weisel Partners

Okay. Great. That's helpful. Thank you very much.

Operator

Thank you, sir. Our next question comes from Aaron Schwartz from JPMorgan. Your line is open.

Aaron Schwartz – JPMorgan

Good afternoon. I had a follow-up question on the guidance and some of the commentary around some maybe spot example of deals that slipped in Europe. Are you assuming maybe a slightly lower close rate in the back half? And if you are, what offsets that to get you to your revenue guidance for the year? Is that really the Dell relationship maybe expanding overseas? Are you seeing some better growth here domestically that you didn't expect? Or can you just walk through the numbers there?

Dean Goodermote

There is – some of it is the amounts of software that will sell in emBoot; Craig mentioned that. And there's always the possibility that that will drive even more business then we've put in there. It's a fairly modest amount. You do have – we still seem to have a good strong Americas – I should stress it's not just North America, but Latin America has been good too, and strong forecast out of Asia. And we hope that Europe does pick up some, so I think it's a combination of all the geographic areas performing well.

Aaron Schwartz – JPMorgan

Okay. And the organizational changes you have – you made in Europe, have you seen any – I know it's very early on so maybe the answer is no – but have you seen any deals that slipped close just due to some of the–?

Dean Goodermote

Yeah, I don't want to focus on the slipped things. To my experience when people say deals slipped is that while they come in its really lost revenue. So, we have certainly seen some of those come in probably due to timing and we still have them forecasted. This is – I don't think that's necessarily because of the organization. I think the organization is just a more effective, aggressive sales organization now than it was previously in the U.K.

Aaron Schwartz – JPMorgan

Okay. Understood. Maybe switching gears to emBoot, it sounds like that is more of a technology that would not be integrated into your Double-Take platform. Maybe I'm wrong there. But if that's the case can you just walk us through maybe the timeline to get that ramped through your traditional distribution, through the–?

Dean Goodermote

Yeah, it will be integrated at some point because I don't know if you recall, but we have this sort of approach of SRO where we're moving – these things will work together where we move full servers over to a transition spot and then launch from there. This will perform similar functions, so it's really going to leverage our Double-Take doing full server movement to the emBoot technology and then having it transfer from there to another place, although we can leverage that starting tomorrow. There will be integration work to do. Some of that will take more than six months, certainly, to get done. Some will – the initial stuff of branding and the easier stuff will be done within a few months, three months. The other stuff will take at least six, but by six to nine months I think we will have a good effective integration. But we will start being able to leverage it tomorrow. So, it really will be related to a Double-Take sale. There will be some ongoing sales without Double-Take, but I think these two, even though they'll be separate SKUs here and there, will be in related customers and related offerings, related sales efforts.

Aaron Schwartz – JPMorgan

Okay. And as you get a little more into the storage sub market is that somewhere you think you can go on your own or do you need to partner with somebody on the storage side to really maybe provide a catalyst to this type of product?

Dean Goodermote

Yeah, well, the storage part of this is more that is mimicking the – or is working as the standard of the protocol. So, it's not pretending to actually store things, but it's pretending to – but it's effectively acting as a vehicle to boot; hence the name. The boot thing, so to take it and move it rapidly from one place to another. So, although it's working off a storage standard it's not storage itself. We are – I see us moving in two directions because of our position. One is this dynamic infrastructure, which is the ability to move things around, but because of the position we are in we are doing things that will move us more into the storage area of facilitating stuff. For instance, we're doing stuff in Hierarchal Storage Management that will be out soon, which will allow you to put certain types of data in one place and certain types in another to enable more rapid recovery. And to that extent we'll probably start partnering more and more with the storage vendors, people that actually do hold repositories. So, yes, we will there, but I don't want to declare war. We're not declaring war on the storage companies with this acquisition.

Aaron Schwartz – JPMorgan

Okay. That's helpful. And last question from me regarding this acquisition and the employees that are coming over. Should we assume you're going to invest incrementally or you have to hire incrementally on the development side for this technology or can you just move over some resources you have internally? You know what I'm getting at?

Dean Goodermote

We have plans to add a couple in the sales types of functions and a couple in the engineering types of functions. We've assumed those.

Aaron Schwartz – JPMorgan

Okay. And I guess that's just part of your plan, 20% to 25% increase this year's in headcount?

Dean Goodermote

Yes.

Aaron Schwartz – JPMorgan

Okay.

Dean Goodermote

Yeah, that will be part of it.

Aaron Schwartz – JPMorgan

Great. Well, thanks for taking my questions.

Operator

Thank you, sir. Our next question comes from Brent Bracelin from Pacific Crest. Your line is open.

Brent Bracelin – Pacific Crest Securities

Thank you. Dean, couple questions here. I wanted to dig in the – hello?

Dean Goodermote

Yes, we're here.

Brent Bracelin – Pacific Crest Securities

Okay, great. Dean–

Dean Goodermote

It sounded like you got cut out a second there.

Brent Bracelin – Pacific Crest Securities

Yes, exactly. I had a question on the macro if at all possible. Obviously, SMB market showing a little slowdown in EMEA. What's unique about the U.S. market where you're not seeing the slowdown? Are you gaining share there? Are your partners stronger? And then how sustainable is that? What's your visibility in the SMB spend and what's your outlook for that market specifically in the U.S. for the remainder of the year given the slowing kind of U.S. economy?

Dean Goodermote

Yes, I think we do see it here in the U.S. for sure, so I'm not trying to downplay it. I just – as I said before, I think it does affect us. We would be doing better if the markets were good. We're big in the financial communities. I can't believe we wouldn't have more orders. But we're just not seeing this serial buying that we saw in Europe. And so there – I think there are a couple things and one, it's a lesson of how we can do better is that we're closer to the hub here. Our products are getting more and more technical; the way they work in the virtual environment. And with all the noise going on out there by all the other vendors, not just our competitors, the message that is sent into the end users and the partners are more complicated than they were even a year ago. So, I think by speaking English and not the Queen's English and being very, very close to our development and our corporate marketing hub, we've been more effective at communicating to our end users, our partners and our sales force the benefits of our technology. I think that's a lesson and we've got to get better at that abroad. Otherwise, I think we just have a more established sales force and partnership arrangement. Dell as we were just talking about is very good in the U.S. That goes back quite a while. We're starting to get leverage – Dell in Europe, but it's new. In the end it’s people, so we just can't say, "Oh, it's Dell and it starts off." We're trying to work HP harder there, but again it’s people. We're trying to work the distributors there. We just signed up what we think is VMware's largest distributor in Europe and are focusing on them, but it's a people business and I think we've just been more effective and focused here and better at communicating here in large part because we speak English and we are here.

Brent Bracelin – Pacific Crest Securities

Great. And my last follow-up is really on Dell and the concept of more of a cloud model. Obviously, Dell bought MessageOne more of an indirect competitor, potentially customer for you guys. You certainly saw no drop-off in your business. How do generally and generically think about kind of the application of backup recovery, archive, replication towards the – to a cloud environment? Is the goal to continue to empower those cloud models? And then maybe talk a little broadly about kind of MessageOne and their relationship with Dell.

Dean Goodermote

I'll answer that specifically. MessageOne is – actually, they're a partner of ours. They use Double-Take. And in fact, the CEO and I still have discussions. So, there is never – there doesn't appear to be any competitive issues there and I'm not hearing – I'd be interested in you – if you're hearing that the cloud – yeah, whatever that is – because it means different things to different people – it sort of affected our position today either with Dell or anyone else. But we are looking at it and we think even things like emBoot and the whole idea of dynamic infrastructure are ways in which we can kind of help power the cloud providers. We do, I suppose, have a potential to be in the cloud ourselves and we certainly talk about that and not ruled that out. The economics of that in working with Amazon or whomever are much different than it was a few years ago. So, we look at that, but today we think of ourselves as really partnering with people to provide the goods to help them build out their own clouds.

Brent Bracelin – Pacific Crest Securities

Sure, yeah. That's certainly a helpful explanation there. I know there's a lot of confusion out there and we're still in very early days. But certainly, the Dell numbers show that you guys continue to have good traction there.

Dean Goodermote

Yeah.

Brent Bracelin – Pacific Crest Securities

Thank you.

Dean Goodermote

Yeah. Thank you.

Operator

Thank you, sir. Our next question comes from Sean Hannan from Needham. Your line is open, sir.

Sean Hannan – Needham & Co.

Yes, thank you. Good afternoon.

Dean Goodermote

Hi.

Sean Hannan – Needham & Co.

Hi. A quick question, I may have missed this. What was the geographic breakdown in the quarter?

Dean Goodermote

I gave the – it was 36% out of international and–

Craig Huke

– the remainder North America.

Dean Goodermote

–and the rest.

Craig Huke

Okay.

Dean Goodermote

Yeah.

Sean Hannan – Needham & Co.

Overall within your business, what was the general level of – other than what you had in the quarter came from existing customers?

Dean Goodermote

I didn't quote that. I believe that was – let me look here quickly. That was, I believe, much higher in the existing customers, too. Just a second. Hold on.

Sean Hannan – Needham & Co.

Sure.

Craig Huke

For the second quarter it was about 55%, 56% came from the existing customer base.

Dean Goodermote

Right. Okay.

Sean Hannan – Needham & Co.

Okay. All right. And I suppose lastly, – well, maybe not lastly – if I can just – from a pricing standpoint, we've gone through a couple of periods where you've announced ahead of time some pricing increases based on introducing functionality within your offering. Is there any color that you can provide in terms of outlook from today and as we look at the inclusion of emBoot?

Dean Goodermote

I don't think we'll be doing – we don't have any immediate plans to do any pricing increases right now. And we have just added more functionality with this Virtual Recovery Assistant, so in some ways we are giving more benefit. The emBoot technology – I don't – I think we're going to try and use that to gain market and not necessarily try to bundle it in and increase functionality in that price somehow to it. I think we're going to really try and increase our footprint in the marketplace with that in accounts we otherwise wouldn't be in even. So, the short answer is no short-term plans to increase prices.

Sean Hannan – Needham & Co.

Okay. That's helpful. And lastly, just in looking at emBoot, just from a competitive standpoint, who would – who should we think about in terms of competing software providers that would have this type of functionality?

Dean Goodermote

A spot that we're not necessarily focused on is – Citrix has some of it. If you look at a company like LeftHand Networks, we're not – I wouldn't say we're competing with them, but they do in some ways they sort of leverage this. If you know them they're a software company, but they use software to become a storage company. So, it gives us that kind of capabilities. Also, the real competitors are like the Host Bus Adapters and the NICs, the Network Interface Cards that you – you can do all this stuff if you go out and you make sure you've set everything up properly and go through the expensive buying all the appropriate cards and hardware and doing all the configurations, but that's exactly what we think we can eliminate. So, I guess the main competitive alternative is doing it some other way.

Sean Hannan – Needham & Co.

Okay.

Dean Goodermote

We do feel like these guys are – there's other ways to skin a cat, so you're likely to hear, "Oh, we can do that." But we feel as if these guys spend a few years trying to figure out this problem. This is not a deal that was brought to us by an agent or a banker and I don't mean any disrespect to them because we see a lot of good things from them, but this was the result of us looking around in the market and we looked at a few places and thought this was the most appropriate for us.

Sean Hannan – Needham & Co.

Terrific. That's very helpful. Thank you.

Dean Goodermote

Thank you.

Operator

Thank you. Our next question comes from Mark Kelleher from Canaccord Adams. Your line is open.

Mark Kelleher – Canaccord Adams

Hi, guys. Let me add my congratulations to a good quarter as well.

Dean Goodermote

Hi, Mark, thank you.

Craig Huke

Thanks.

Mark Kelleher – Canaccord Adams

Sorry if I missed this, but did you give the percent of revenue that's connected to virtualization, that is related to virtualization?

Dean Goodermote

Yes I did and I'm not giving it again. Yeah, it was 11% and it went with my – always my caveat that we really can't track the ones and twos and threes that we do and we often do, do them, but a lot people are still – I'm not sure if you read about this, but a lot of stuff – the production servers still aren't being virtualized. So, they may create a disaster recovery with one virtual server, but still being – tying the exchange server, the physical server and they'll buy two copies of Double-Take and those will never show up. But with the ones we can count, it was 11% of the total product sales, not maintenance and things like that, but the product sales.

Mark Kelleher – Canaccord Adams

And you expect that to pick up a few percent–?

Dean Goodermote

It was up a little, yes.

Mark Kelleher – Canaccord Adams

Okay. And then just maybe on the competitive – on the mainline products, the competitive position. Anything changed during the quarter?

Dean Goodermote

No, that hasn't changed. I feel like it's the same old same old. We're starting to be a different Company, so the Company that CA bought or where EMC is with RepliStor, maybe some of the comparative stuff with Symantec or the company Neverfail, they're still there, but I feel as we're branching out we're just starting to – we're engaging other types maybe in the virtualization space. There's a company called Vizioncore and we – in one area we compete with them in doing the ESX guest replication. PlateSpin, which is still a partner of ours. Sometimes both of us can do the same thing in migration although often we will still refer companies to them and vice versa. So, we're starting to see competitive touching with other accounts for companies specifically targeting the virtualization space.

Mark Kelleher – Canaccord Adams

Okay. Great. That's all I've got. Thanks.

Dean Goodermote

Thank you.

Operator

Thank you, sir. Our next question comes from Manish Hemrajani from Oppenheimer. Your line is open.

Manish Hemrajani – Oppenheimer & Co.

Hi, guys. Good quarter.

Dean Goodermote

Hi, Manish.

Manish Hemrajani – Oppenheimer & Co.

Any color on the Linux product? You said you had some revenue in 2Q and any comment on the pipeline? How does that look for the Linux product?

Dean Goodermote

Well, it looks better. I mean after saying we weren't expecting anything, I think we've seen some sales. What we saw, really, was maybe some pick up in the education market, so maybe that will be a place for us to go. But it went from zero to something. As I think you know – we've actually haven't announced it yet. So, the people on this call tend to know more about it than the market does. We'd like to make sure that we have a product that's going to be used in the market so we're probably at the point now where we want to start pushing it.

Manish Hemrajani – Oppenheimer & Co.

What's the pricing on that?

Dean Goodermote

It's similar to Double-Take.

Manish Hemrajani – Oppenheimer & Co.

Okay.

Dean Goodermote

Exactly the same, actually.

Manish Hemrajani – Oppenheimer & Co.

Okay. Did you say anything about the average deal size this quarter?

Dean Goodermote

Yes, it was the same as the quarter before.

Manish Hemrajani – Oppenheimer & Co.

Okay. Got it.

Dean Goodermote

6,000 for the median – it rounds to this you know but it’s about 6,000 per median and 11,000 for the average.

Manish Hemrajani – Oppenheimer & Co.

Got it. That's all I have. Thank you.

Dean Goodermote

Thank you.

Operator

Thank you, sir. (Operator instructions) Our next question comes from Walter Pritchard from Cowen & Co. Your line is open.

Walter Pritchard – Cowen & Co.

Thanks, guys. Just wondering, a couple final questions. Most of them have been asked. Just wondering if you look at – I guess this has been asked a different way, but if you look at the guidance that you've given for Q3, I'm just trying to get a sense of exactly what you're embedding in there for Europe; if you are thinking that things are going to be back to normal, where they were two and three quarters ago or if they're going to be more in line with what they were in Q2.

Dean Goodermote

I don't think we think they're going to be as strong as we thought they were going to be at the beginning of the year. So, we've adjusted our outlook down for that. There's a little bit of emBoot in there and continued strong performance out of the U.S.

Walter Pritchard – Cowen & Co.

Great. And then it looks like around the emBoot acquisition in Q3, you said you're taking on about $100,000 in amortization expense and about $100,000 in retention bonuses in the third quarter. Are those similar numbers to what they will be in the fourth quarter as well?

Craig Huke

Walter, yes. That will actually be – the full quarter amortization is going to be $125,000 a quarter and then the full quarter for the retention is about $100,000. So, both of those even with Q3 rounded to those numbers.

Walter Pritchard – Cowen & Co.

Got you. And then just last question around TimeData. I think Q3 or here in the second half you were going to ship a new version there or the revenue thus far has been pretty minimal. Just wondering if you can you give us an update on timing around TimeData and any detail around expected revenue contribution in the second half?

Dean Goodermote

Yes, well we think we want to get going this half, so we should start seeing some – we had a little bit of an uptick at the very end of June where we got 15 licenses or something more, but we expect to start producing this quarter and certainly more next.

Walter Pritchard – Cowen & Co.

And do you think, Dean, that everybody is – everybody meaning your internal staff as well as your partners are adequately trained on that product or is that still a (inaudible) in terms of getting that business ramped up?

Dean Goodermote

I think that I thought they were well trained, but I think that they have to continue to be told because it's a partner model. So, you have to – I think this is particularly true in Europe is we launched it, but we need to keep following up. It's a little different animal than Double-Take and so we do need to keep reminding them. It does take sort of a quarter to two – unrelated to the technical aspects. My sense is with a partner model as opposed to direct sales partners work quick once you get them up to speed, but it's a good six month effort at getting them up and running and that's what we've been doing now. So, we really do need to continually educate them. And we recently just got somebody on board to focus on that full-time just because – just doing it as a matter of course I don't think it's sufficient.

Walter Pritchard – Cowen & Co.

And then last question, Craig, on – in the services line I know you include a small amount of professional services in there as well as the majority being maintenance. Could you just give us a sense of any change in the professional services contribution in that line this quarter?

Craig Huke

The number, Walter, it really – as a percentage of the total it's actually trending down a little bit as the maintenance is growing much faster than the actual PS. So, it's less than 5%. I don't have the exact amount, but it's staying a pretty small part of the total.

Walter Pritchard – Cowen & Co.

That's 5% of total revenue or 5% of the service line?

Craig Huke

5% of that line item.

Walter Pritchard – Cowen & Co.

Got you. Okay. Great. Thanks a lot, guys.

Dean Goodermote

Thank you, Walter.

Operator

Thank you, sir. And at this time, I'm showing no further questions. Ladies and gentlemen, we thank you for your participation. This does conclude today's conference.

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