Commvault Systems, Inc. (CVLT) Q3 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the CommVault's Fiscal Third Quarter 2012 Earnings Call. [Operator Instructions] At this time, for opening remarks and introductions, I would like to turn the call over to Mr. Michael Picariello, Director of Investor Relations. Please go ahead, sir.

Good morning. Thanks for dialing in today for our fiscal third quarter 2012 earnings call. With me on the call are Bob Hammer, Chairman, President and Chief Executive Officer; Al Bunte, Chief Operating Officer; and Lou Miceli, Chief Financial Officer. Before we begin, I'd like to remind everyone that statements made during this call, including in the Q&A session at the end of the call, that relate to future results and projections are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are based on our current expectations. Actual results may differ materially due to a number of risks and uncertainties, which are discussed in our SEC filings and in the cautionary statement contained in our press release and on our website. The company undertakes no responsibility to update the information in this conference call under any circumstance. Our earnings press release was issued over the wire services earlier today, and it also has been furnished to the SEC as an 8-K filing. The press release is also available on our Investor Relations website. On this conference call, we will provide non-GAAP financial results. The reconciliation between the non-GAAP and GAAP measures can be found in Table 4 accompanying the press release and posted on our website. This conference call is also being recorded for replay and is being webcast. An archive of today's webcast will be available on our website following the call. I will now turn the call over to our CEO and President, Mr. Bob Hammer.

Thanks, Michael, and good morning, everyone. Thanks for joining our third quarter FY '12 earnings call. We had a strong quarter in all aspects of our business. We set records for both revenue and earnings and we topped the $100 million mark in quarterly revenues for the first time. Let me briefly summarize Q3 FY '12 financial results. For the quarter, total revenues were a record $103.6 million, up 24% year-over-year and up 6% sequentially. Software revenue grew 23% year-over-year and 8% sequentially, while services grew 25% year-over-year and 5% sequentially. Geographically, we had strong growth in the Americas, Europe and China. For the quarter, non-GAAP operating income or EBIT was $19.6 million, up 31% year-over-year. EBIT margins were 19%, non-GAAP diluted earnings per share for the quarter was $0.27. For the first 9 months of fiscal '12, we grew the top line by 30% and we achieved solid EBIT expansion of 220 basis points. We generated over $27 million of cash flow from operations during the quarter and approximately $70 million for the first 9 months. The positive results for the first 9 months of fiscal '12 have been primarily due to the combination of the following key factors: Simpana 9 software significantly increased our technology differentiation versus all key competitors; improved sales execution in major enterprise accounts; increased brand awareness aided by CommVault's industry-leading position by respected third-parties such as Gartner; and increased distribution leverage from both our strategic and reseller partners; and improved execution in all segments by our globally realigned sales force. I'm going to talk about and spend a minute on enterprise accounts. Enterprise deals, which we define as deals over 100,000 in software or 40% of license revenue in the quarter, representing 20% year-over-year growth. Our average enterprise deal size was approximately 269,000 during the current quarter compared to 219,000 in the prior-year period and 208,000 in Q2 FY '12. Enterprise deal flow momentum and funnel growth continued to be strong, which helped improved our visibility into Q4 fiscal '12. For the first 9 months of fiscal '12, the dollar value of enterprise software transactions decreased by 48% over the comparable 9-month period in the prior year. In addition to Simpana 9, improved enterprise account penetration was due to better execution from our enterprise sales teams and creates contribution from our strategic distribution partners, improving distribution and channel partner effectiveness and more effective marketing and branding. The enterprise segment strategy that we deployed in early FY '11 is working and is validated by a solid results over the past few quarters. We will continue to aggressively invest in customer facing sales and technical resources as we continue to penetrate the segment of the market. I will talk more about Simpana 9 after Lou's comments, but the following example provides a good overview on why customers are choosing CommVault. This customer is a large government agency and this was a 7-figure deal. They chose CommVault because they were able to deploy one strategic unified platform versus multiple point products, reduced costs by minimizing IT spend while meeting compliance objectives with our embedded archiving and search capabilities, more effectively managed scale to meet current and future needs and reduced staff to a single person, who was able to manage very complex environments with Simpana's comprehensive Management Console. The customer is expected to save approximately $4 million, or 3x return under initial purchase of Simpana, and that does not include the additional labor they would have to hire with our key competitors' solutions. I will now spend a minute on product mix. As I indicated last quarter, we will no longer provide backup versus advance data information management or ADIM's statistics. As the traditional backup function is disappearing and being replaced by more advanced data management functions like Snap and Replication, source deduplication and archiving. In addition, approximately 2/3 of our license sales are now sold as capacity-based platform -- are now sold as capacity-based platform sale and continue to increase as this licensing model resonates with customers. When we sell our platform through a capacity license, different Simpana functionalities are bundled into one capacity-based price. This pricing model makes it much easier for customers to buy our unique Simpana platform as a factor in our increasing market share gains. However, the sale of such bundled products under a capacity licensing arrangement makes a distinction between backup versus ADIM stats no longer relevant. During Q3, the strength of our business was driven by strong demand from the following Simpana functionalities: virtualization solutions, source-side deduplication; SnapProtect data management solutions and archiving. I will now address our current outlook. We have seen limited negative impact to our business from the macroeconomic environment. Our funnels continued to grow at the required rates and we have increasing visibility to our current core forecast. At the present time, we see good demand across all vertical sectors of the market and across all geographies. However, we are well aware that the current economic climate has added a lot of uncertainty about future demand. While we have strong consistent growth in revenue and earnings, I would like to add the following words of caution regarding our future outlook. We continue to have quarterly revenue and earnings risk due to the timing of very large 7-figure deals. There remains global macroeconomic uncertainty with indecision around IT budgets for calendar 2012. Almost all the analysts are forecasting lower spending in tech versus a year ago. We will continue to watch IT spending closely. We had a particularly strong quarter contribution from the federal government in Q3, which is historically something we did not see in the quarter following the federal government year end. And lastly, while EMEA had a good year-over-year revenue growth in Q3, we continue to be cautious on the European economic IT spending outlook, as well as potential negative revenue impact from further weakness within the Eurozone. We will accelerate spending going into Q4 FY '12 and FY '13 in order to take advantage of our unique position in the industry to take up additional market share. In spite of the significant increase in spending, we still believe we can improve operating margins by approximately 100 basis points in FY '12. For FY '13, we believe we are well positioned to achieve above-industry average revenue growth rates and improved operating margins driven by strong market traction with Simpana 9, continued increases in sales effectiveness, added sales capacity, as well as broadened distribution. We believe we will be able to achieve solid digit revenue and EBIT growth in FY '13 as our forecast and visibility look promising. In summary, the company had another solid quarter and is in good position to successfully achieve our annual objectives for fiscal FY '12. We are establishing a solid foundation for growth in FY '13, we are aggressively making the required investments to ensure that we can continue to outpace the market and growth and profitability over the medium to long term. The acceleration of revenues, earnings and visibility over the past several quarters has enabled us to achieve our FY '12 financial objectives and increase the probability of achieving our objectives for FY '13. I will now turn the call over to Lou.

Thanks, Bob, and good morning, everyone. I will cover the key financial highlights for the third quarter of fiscal year 2012. Total revenue for Q3 was $103.6 million, an increase of 24% year-over-year and 6% sequentially. During Q3, revenue from U.S. operations generated approximately 61% of total revenues, resulting in a 26% year-over-year increase, while revenue from international operations generated 39% of total revenues, resulting in a 21% year-over-year increase. On a year-over-year and sequential constant currency basis, foreign currency movements did not have a material impact on neither Q3 revenues or earnings per share. The revenue mix for the quarter was 50% software and 50% services. In the prior-year period, the mix was also split evenly. For the quarter, we reported software revenue of $51.4 million, which was up by 23% or $9.7 million over the prior-year period. As Bob mentioned, our software revenue from deals over $100,000 increased by 20% over the prior-year period and declined 8% over the prior quarter. The number of enterprise software deals over $100,000 declined 2% year-over-year and [Audio Gap] sequentially. However, our average enterprise deal size was approximately 269,000 during the current quarter compared to 219,000 in the prior-year period, and 208,000 in the prior quarter. This increase in the average deal size was driven by more deals greater than $1 million as compared to last quarter, as well as strong growth in high 6-figure deals. In addition, our SMB business grew 26% sequentially primarily on the strength of our global SMB channel partners, dedicated inside sales teams, and some new specialized pricing bundles for the SMB market. Services revenue for Q3 was $52.2 million, an increase of 25% year-over-year and 5% sequentially. Software revenue derived from indirect distribution channels represented 88% of software revenue, which increased by $10 million or 29% year-over-year, and $2.8 million or 7% sequentially. Please keep in mind that our direct sales organization is a strategic overlay to our channel partners, and we will continue to invest in our direct sales force which is essential to achieving our growth targets. Sales through our Dell relationships, including Dell services, accounted for approximately 23% of total revenues for the quarter. Total quarterly Dell revenues grew 40% year-over-year and 12% sequentially. Total revenue through Arrow contributed approximately 27% of total revenue growing 22% year-over-year and 6% sequentially. Revenue contributions from our OEM agreements with NetApp and Fujitsu were in line with current quarter expectations. Our U.S. federal government business declined in Q3 versus the strong federal government business we saw in Q2, which was tied to the federal government September 30 year end. As a result, on a sequential basis, the U.S. federal -- business declined 12%, but grew 44% year-over-year. Our U.S. government business remains a strong vertical for us, representing 8% of our total revenue for the quarter. We added over 400 new customers in the quarter. Our historical customer count now totals approximately 15,600. Gross margins were 87% for the quarter, relatively flat sequentially. Total operating expenses were $69.4 million for the quarter, up approximately 6% sequentially and 21% year-over-year. Sales and marketing expenses increased by $10.7 million, or 26% over the prior-year quarter, and $3.6 million or 7% sequentially. The increase in sales and marketing expenses is primarily due to higher commissions on record revenue and investments made in field sales and field technical resources. We ended the quarter with 1,389 employees, up from 1,371 at the end of September. We expect the number of headcount adds in Q4 to be substantially higher than the heads added in Q3 as we continue to build out our sales and support organizations to meet our growth targets for fiscal year 2013. Non-GAAP operating margins were 19% for the quarter, resulting in non-GAAP operating income of $19.6 million. On a year-over-year basis, EBIT increased by 31%. For the full fiscal year 2012, we anticipate that our margins will improve by approximately 100 basis points over fiscal year 2011. I would like to highlight one key spending increase in Q4. Historically, we see a large sequential increase in employer-paid FICA tax -- FICA expense in Q4 because many of our employees in the U.S. reach the FICA limit well before the end of the calendar year. This year, we expect our FICA expense in Q4 to be approximately $1.2 million higher than Q3. For fiscal year 2013, we expect to improve operating margins by approximately 75 to 100 basis points. While we believe we could deliver greater margin expansion in fiscal year 2013, we are making strategic investments that enhance both our short and long-term growth opportunities and advance our leadership position in the market. As I said earlier, our headcount adds in Q4 will be substantially higher than Q3, and we will invest heavily in the beginning of fiscal year 2013 on front-end technical support teams, as well as more sales professionals as we are a high-touch sales model and we cannot successfully penetrate the enterprise segment of the market without these teams. The non-GAAP net income for the quarter was $12.7 million or $0.27 per diluted share based on a diluted weighted average share count of approximately 46.8 million shares, and a 36% pro forma tax rate for Q3 of fiscal 2012 versus a 34% pro forma tax rate used in the prior year. We anticipate that our annual average diluted shares will be between $46.8 million and $47.3 million for fiscal year 2012. For fiscal 2013, we anticipate that our diluted weighted average share count will be approximately 1.7 million to 2.2 million shares higher than the fiscal 2012 diluted share count. As a reminder, the company is planning to use a pro forma tax rate of 38% in -- for fiscal year 2013. For the current fiscal year, we are using a pro forma tax rate of 36%. We anticipate that the cash tax rate for fiscal year 2012 will be in the range of 20% to 25%. We expect our cash tax rate to remain lower than our GAAP tax rate through fiscal 2013. Our cash tax rate will approach a long-term terminal GAAP tax rate over the next 1 to 2 fiscal years. As of December 31, our cash and short-term investment balance was $257.2 million. For the quarter just ended, cash flow from operations was $27.7 million. Free cash flow, which we define as cash flow from operations less capital expenditures, was $26.2 million for the quarter, which is an increase of approximately 198% over the prior-year quarter and an increase of approximately 171% sequentially. For the quarter, our DSO was 59 days, which is down from 61 days in the prior quarter, mainly due to better linearity. As of December 31, 2011, the company's deferred revenue balance was approximately $130.8 million, which is an increase of $27.6 million or 26% over the prior-year period and up 5% sequentially over the prior quarter. That concludes my financial highlights. I will now turn the call back over to Bob.

Thank you, Lou. I want to spend a few minutes discussing the new Simpana 9 innovations that were announced in our press release this morning. I will also discuss more broadly our customers key IT data and information challenges and why we are best-positioned to address both challenges. As part of our Simpana 9 press release, we announced an exciting industry-first, Simpana OnePass. A new Simpana OnePass converges backup, archive, analytics and deduplication into a single process, reducing combined operation time by more than 50% compared to traditional methods. Simpana OnePass also enables customers to reduce data management cost, reduce business and compliance risk and more easily extract data for better decision-making with anywhere, anytime information access. We also announced in the press release that Simpana SnapProtect now delivers the industry's broadest hardware Snap integration which protects customers existing SAN environments, eliminates the backup window, accelerates recovery and reduces costs. Our new Simpana Edge Protection protects data on laptops, desktops with embedded source-side deduplication for optimized efficiency. There are many other enhancements in this press release, including significant improvements in managing data in virtualized cloud and SharePoint environments. Please note, we will provide a lot more detail on these and many other enhancements of Simpana 9 at our SolveForward 2012 virtual tradeshow beginning at 11% Eastern Time today on our website. Our objective with Simpana 9 is to provide solutions to solve the critical issues for our customers. Those issues include: Data continues to grow at faster rates than systems or budgets can support; keeping up with rapidly changing infrastructures, including virtualization, data center consolidation, new storage networks and the cloud; demands for better scalability and performance; edge devices, including laptops and tablets are proliferating and that IT is mandated to support and ensure proper controls are in place to protect data on these critical corporate assets. Accessing the mission-critical data that now resides in the data center, the cloud and edge devices, figuring out how to support increasing regulatory compliance and e-discovery requirements and extracting data and use analytics for better decision making. Compounding all of those issues is a need to reduce infrastructure, administrative and operational costs. Our competitors are trying to provide solutions to the same issues but are addressing the market in a very different way. They offer a myriad of disk break point products that are proven to be very costly, less reliable and more difficult to support. In addition, each product has its own interface, catalog, and associated hardware. The data stored on those products are siloed, making it more difficult to access and search data for compliance, regulatory, legal and decision making. We believe we are doing a better job of solving our customers' challenges because we're able to solve their problems globally and holistically across all IT environments with one single platform that is ultimately less expensive, provides more functionality, is more reliable and is much easier to support. Not only do we have the most comprehensive platform in the industry, customers confirm that we also have the best-in-class products as part of that platform and unrivaled customer support and services as well. Clearly, CommVault is distancing itself from its competitors and doing a better job in meeting enterprise data and information management challenges. Our results are a good indication of this. Our objectives are to continue to increase our leading innovation with both products and services, expand it to new markets, broaden and increase the effectiveness of our distribution and improve our execution across the enterprise. Let me spend another minute on OnePass and our new ContentStore data repository. As I mentioned earlier, CommVault's new Simpana OnePass is a very exciting industry-first innovation that converges backup, archive, analytics and deduplication into a single process. This is important because the merger of backup and archive makes it much simpler for administrators to establish automated policies that exactly match business and regulatory requirements and be assured that those policies are carried out. The initial release is targeted to Windows File Systems. We expect to deliver OnePass for other file systems and applications at a later date. The other exciting key element of our OnePass innovation is ContentStore. With ContentStore, customers will be able to store data from a multitude of locations and sources into a single enterprise-wide repository. In summary, ContentStore is an intelligent, virtual repository that provides an efficient and scalable foundation for eDiscovery retention and decision-making. The key benefits of OnePass in ContentStores are compelling. They will enable our customers to lower costs by reducing the number of copies to be managed and applying deduplication at the source, simplify the management of data into a single set of unified policies, dramatically reduce the backup window by moving the data only once with SnapProtect and using ContentStore for regulatory compliance and to enable more intelligent, timely decision-making. CommVault will continue to be a visionary in the industry. Guided by our solving-forward philosophy, we are committed to being the innovative leader in the market. In this regard, in addition to the Simpana 9 enhancements announced today, we have the strongest product pipeline in our history. In closing, we believe CommVault's financial performance relative to its peers has improved due to accelerating product innovation and increasing technology differentiation, better sales execution, increased brand recognition and improved distribution. We also have been able to achieve good operating margin improvement and increase shareholder value. Our objective this quarter is to meet our quarterly goals and establish good momentum going into FY '13. We are making all the necessary investments to strongly position the company for the longer term. We are currently tracking ahead of our schedule to achieve our billion-dollar plan objective. We are accelerating product and services innovations, continuing to improve sales effectiveness, distribution leverage and broader brand recognition. I'm highly confident that we will continue to lead the industry in revenues and earning growth. I will now turn the call back over to Michael.

Thanks, Bob. Operator, can we please open the line up for questions?

[Operator Instructions] Your first question comes from the line of Joel Fishbein with Lazard Capital.

I just have a couple of clarifying question or one clarifying question and then one follow-up. Bob, I just want to reconcile what you said about margins. It's clear that you guys want to reinvest in growth. And in fiscal '11, you did roughly 17% operating margins and you're on track to do 18% -- roughly 18%. I just want to make sure that I understand in terms of what you're saying about your Q4. Are you planning on being down sequentially in terms of operating margins because of reinvestment or how should we think about Q4, which has usually have been a strong operating margin quarter for you?

As Lou said, we could do better, but we are significantly making major investments this quarter. You're going to see it show up in our headcount. So we could do better, we think the prudent thing to do is provide approximately 100-point guide of operating margin improvement for Q4. So that would imply that we could be down quarter-on-quarter.

Okay. Down quarter-on-quarter on Q4 but up -- but it'll be up 100 basis points for the year?

That's correct.

Okay. I just want to make sure. Second thing is $257 million in cash, didn't buy back any stock, what are your thoughts there in terms of use of cash and how much cash do you need to use -- run the business?

Well, we don't need very much cash to run the business, obviously. But we've got -- we are always opportunistic in our buyback approach and we'll continue to be opportunistic in that regard. We also have going -- for the future, we have some other ideas on where to deploy cash and when those firm up, I'll discuss those further.

Does that mean that your turn -- may turn to M&A now for -- to enhance growth?

No. The billion-dollar plan is clearly, at this point, all organic, and as I mentioned in my earnings comments, we are ahead of schedule to achieve that objective and our attention -- that's why we're making these big investments now because I think we can stay ahead of schedule meeting that critical objective.

Great. And then the follow-up is just in terms of -- any more color on some of your partnerships that you have -- Lou made some comments about NetApp and Fujitsu, but love to get any more color that you can give in terms of how they're helping you expand your distribution and hit that billion-dollar target.

What I'll say first off is that our current enterprise sales execution and our current distribution capability is clearly providing above-target level results without those 2 additional partnerships, which is really gratifying. Fujitsu clearly is right on track or maybe a little bit ahead of their schedule. NetApp hit its objectives for the quarter, but over the longer term, it's slightly behind schedule, but we expect to see a significant step-up from NetApp in the March quarter.

Your next question comes from the line of Eric Martinuzzi of Craig-Hallum.

You broke up on the growth outlook commentary. Were you saying double-digit for FY '13, was that correct, Bob?

Correct.

Okay. And just given where we've -- if I could follow up or maybe bring it back to the current year, if I look at the organic growth, it's been very impressive, for the 9 months were a little over 30%. I know Street consensus number is about 16%, 17% for Q4. Is there any reason, at least top line, why that decel -- well, maybe I should ask it in a different way. What's your comfort level with The Street revenue estimate for your March quarter?

We are comfortable with The Street estimate for our March quarter.

Your next question comes from the line of Jason Ader with William Blair.

I guess just on that last point. Bob, the last 2 fiscal years, you saw a sequential growth in Q4 actually below sequential growth in Q3, and I was wondering if you could comment on that and whether that's sort of a new pattern or just kind of nothing to -- no pattern to speak off. And then secondly, just on the new Simpana capabilities announced. Do you think that this could slow down the sales cycle at all because there's so much new that you guys have just made available and the customers need to evaluate it or do you view it as sort of not missing a beat?

Well, on the second point, we won't miss a beat, and it will clearly help us achieve our FY '13 objectives because these are substantial improvements to the platform. And we can talk about those a little bit more later. As far as the Q3, Q4, I mean, the issue is we had -- these are just comp issues, year-on-year comparative issues. As I said last quarter, the comps are tougher, and we had a very strong Q4 a year ago. So that's all it is. But the underlying strength of the business is definitely improved.

I guess the question is, would you normally expect Q4 to see the largest sequential growth in your fiscal year? Is that -- I mean, I guess, that was the way it was pre-recession. I look at the numbers, but the last 2 fiscal years...

I think we're achieving more consistent quarter-over-quarter growth rates. So I don't think the prior patterns, historical patterns, may not be as relevant because we are able to hit our targets, and you can see it in our DSO with higher visibility going into the next quarter.

Your next question comes from the line of Robert Breza with RBC Capital Markets.

Bob, I was wondering if you could talk a little bit more about the investments you're making here in Q4. You talked about increasing the high-touch sales force. Do you also plan to make additional distribution extension such as the NetApp relationship, Fujitsu, et cetera? When might we expect to see some of those announcements?

Well, the key investments are in our field sales capacity and we are making -- and Al can talk about this here in a second, I'll let him comment on it. We are making significant investments in our field facing technical resources, and this includes our technical account management, solution architects. Those types of investments are critical for us to penetrate larger and larger enterprises globally. And outside our initiative here, we are executing it. And I'll let Al comment on it for a second.

Yes, Bob. What Bob said is quite accurate, of course. Again, we're trying to focus our investments on the technical side of the equation, particularly field facing or customer-facing type of resources out there and that includes the continuum of early presales guys, solution architects, as Bob mentioned, even our professional services organization and there we're also beefing up our capabilities, our enterprise offering. So it's a stream of resources and headcount fills that we're focused on for this quarter.

Maybe a follow-up, Al, when you look at the capacity that you're adding, I'm wondering if you could kind of talk to us quantitatively about the capacity you're adding versus -- or as well as the productivity improvements you're seeing over the distribution. That would be helpful.

Well, I could, but I won't. We normally don't talk about those things, Rob. But it's -- you're right on the money is -- we think, particularly in the enterprise environment, these types of resources are critical to not only customer success and customer satisfaction, but our productivity, if that makes sense to you. And I mean, and it starts right from these POCs out there. They're complex, they're demanding and you need to have a strong contingent of technical resources right on hand there. So that's where the focus is going and that's where our investment's going.

You're right on one other theme, Rob, and that is we have beat our productive -- internal productivity targets. So we're ahead of our objectives in that regard. And that comes from more effective execution from our sales force and much better distribution leverage, not only in the enterprise, but as Lou mentioned, we've gotten -- had now had really good success in the SMB market through inside sales, better distribution leverage. And Al and the team have worked on doing a much better job of bundling products and pricing for that segment of the market. So when you see well above 20% growth in SMB combined with the strength of our enterprise, that provides a lot of balance across the whole spectrum of customers and for data and information management.

Your next question comes from the line of Rajesh Ghai with ThinkEquity.

A couple of questions on your capacity licensing model, if I may. Based on your experience over the past year and quarter since you launched Simpana 9, can you tell us what percent of deals are now involve the new pricing model? And how soon typically customers come back to augment capacity, the original capacity that they bought and how much has that addition typically been?

Yes. As Lou said, or I said, it's approximately 2/3 of our license revenue was capacity-based, and that has been increasing quarter-over-quarter. And the renewal on that, I don't think we have enough data yet to say again what that's going to look like, but clearly, customers are starting to add additional capacity from their original capacity-based licensing deals. And yes, it's still a little bit too early for us to comment on what that annuity is going to look like.

On an average, how soon are they coming back, and typically, how much extra is that augmentation typically? Can you give us some ballpark numbers?

Well, like Bob said, Rajesh, it's too early to say, so. Averages just don't mean much. Again, it's positive there, from what we've seen early on.

Sure. So you typically have an 18-month development cycle. So we should put the release, the next major release around April 2012 timeframe. So given that you just announced some product announcements this morning related to Simpana 9, is that major cycle, the one that you're announcing today, or is there -- there's going to be something else that's going to come out in April?

I think what you're saying -- Rajesh, a good question. We are on a much -- we are on an accelerated release cycle. So we take Simpana 9, we released it and then there's a series of interim releases between the Simpana 9 and our next major platform release. And we'll have -- we'll continue to release additional enhancements to 9 throughout 2012 calendar. I would say that we are on track to probably release the next major platform a little bit earlier than the April timeframe you suggested, and it will be significant.

Does that pose any risk to the current quarter if you have a major release come out in the fourth quarter?

No. I mean, we've never -- we've managed that really well in our 12-year history. And now we've got, I don't know, how many -- 30 major releases out there. We've never had a negative impact from our release, ever.

Your next question comes from the line of Aaron Rakers with Stifel, Nicolaus.

First, I just want to understand one thing that was brought up earlier. Lou, you had mentioned about the FICA tax rate or tax implication. Can you remind me again what that was? And I believe when you guys non-GAAP the numbers, if that's included in what you back up from a non-GAAP operating margin basis, or put another way, if I heard you right, looks like that adds about a percentage point to the non-GAAP gross margin. I just want to understand how -- I'm thinking about that in the context of what that would therefore then imply. You're telling us on a non-adjusted, non-FICA impacted operating margin.

I was talking about GAAP numbers. I was talking about increases to our operating expenses. We have U.S. employees who reached the FICA limit early in the year. So what happens in the fourth quarter of January through March is the FICA comes back. So that's going add to our operating expenses incrementally over Q3, roughly $1.2 million.

And so that is not the FICA expense that's backed out of the non-GAAP number?

That FICA expense is just related to stock option exercises. It has to do with the FAS-123(R) expenses.

Okay. And then as a follow-up, clearly, you guys have a lot of traction in the enterprise deals and you're getting into larger deals, but one of the metrics you threw out there was a down enterprise number of deals, down, I think, 2% and 20% or something like that sequentially. Were there deals in the pipeline that at all kind of pushed out at the end of the quarter? Or can you give any context around that decline in the number of deals that you saw this last quarter?

I think, what we said, Aaron, is our visibility improved, which basically implies that we have a strong pipeline of large deals going into Q4.

Your next question comes from the line of Michael Turits of Raymond James.

Michael Turits. Back on the seasonality question. Typically in the last couple of quarters, you've done kind of mid-single digits, 5-ish percent license growth into the fourth quarter. Is there any reason why whether it's because of the strong federal quarters or something else that we wouldn't see that typical kind of seasonality in the quarter?

I think what we said, Michael, was that we're comfortable with Street consensus at this point.

Okay. And on the services side, is there any reason why you should start to see better seasonality there in fourth quarter? In other words, are you starting to see more -- maybe more coterminous and early in the quarter renewals that would make that a stronger seasonal quarter-over-quarter rate in that fourth quarter?

I don't think so. I mean, so the issue as we grow as a company, your 7-figure deals, for example, have a lower maintenance rate as a percent of sales attached to them. So you;ve got -- obviously, that whole deferred and maintenance growth rate has been going up dramatically because we're -- we got some very high license revenue growth. But no, I wouldn't imply that you get a kick, although, it's possible. If we have really, really good linearity, you might see some improvement there.

Okay. And then the last question, when you said other uses of cash, not buybacks, not M&A, what you've used cash during the past, I would assume is more related to the channel. Anything you can tell us about what we should expect? I mean, is there another -- is your idea to make another big investment in the channel partnership that would require some cash?

No. No. No. But we do have some opportunities for additional channel leverage besides the ones that we have today. We may be able to talk about it on the next couple of quarters.

Your next question comes from the line of Glenn Hanus with Needham.

Just maybe you could spend just a minute on the R&D investments in the near term here. Are you also accelerating that? And can you talk to the extent you're willing a little bit more about the pipeline and what kinds of capabilities to expect from you as you roll out further enhancements to Simpana 9 and then Simpana 10.

Right. The reason I didn't mention those things on this call was that I just didn't want to confuse the message with the R2 release today. We will comment a lot more on those in our next earnings call. I'll tell you that Al and the team have done an awesome job here of accelerating innovation. And I'll just leave it at that. But on a relative basis, our pipeline of innovation is up substantially, and Al is increasing investment in dev to accommodate that. I don't know if you want to -- help me out, just give a little broader commentary on where we're going here on data information, not in terms of scale or just some things -- areas that we're focusing on.

Yes. Glenn, Bob's right. We're cranking up our investment a little bit more on R&D. Our overriding objective going forward is to put distance between us and our competitors. I mean, myself, my dev teams, my product teams, that's our objective. And again, as Bob is alluding, we're seeing a lot of opportunities around -- particularly around the dynamics Bob talked about. You have this continuing march of data growth out there, and so a lot of things we do were focused on scale and performance. You're also seeing an increasing need and awareness and openness to be able to use that data. So ideas around analytics and access to that information are all driving parts of our innovations and product and technologies going forward. So on a broad basis, that's what we're doing and that's what we're trying to do.

Your next question comes from the line of Brian Freed with Wunderlich Securities.

I wanted to get a little bit more clarification around your guidance. You guys have expressed comfort with consensus which is about $105 million. And as I -- I tried to apply the 100% growth -- 100 basis point gross margin improvement for the year, that implies about 180 basis point sequential decline in Q4, about $2.9 million in incremental OpEx and and EPS of $0.24, consensus is 27. Am I applying that all right?

I think your math is correct.

Your next question comes from the line of Aaron Schwartz with Jefferies.

I don't know if this is for Bob or Al. But you guys are talking more about analytics in intelligent decision-making and solutions in that area. If you move forward with this, do you think you need to sell to different folks within the enterprise and sort of broaden those relationships or would you still sell to the same relationships that you have?

So the key -- think about it conceptually. First, you've got to get data off the front end, as Al suggested. There's massive scale. You got to find ways to get data off sufficiently. And so when we talk about SnapProtect and then combining the archive function with backup and then moving it into a universal repository, that's your foundation for any, I call it, information-based applications. And it's unique in the industry in terms of scale, performance, process -- and ability to do it efficiently from a cost standpoint. And then as Al mentioned, you've got to get the data back in a very efficient way. And we're doing -- we -- those innovations that we're talking about this morning are dramatic improvements of what's traditionally been used in the industry. Once you've got it in the -- you've got yourself control of the content, now you've got a repository where you can -- where you put analytics and start to provide vertical solutions to solve real business problems within the enterprise, in addition to your compliance, legal and ediscovery requirements. So the answer is, yes. Once you start to move into vertical and to solutions, you're now starting to sell to other functions within the enterprise, absolutely, which implies new channels, new overlays, verticalization as the company, over the next few years, transitions to that type of value add. So a lot of implications with that. The good news is that our underlying business is strong and we built the foundation from which to transition the company over the next 3 to 5 years to a much higher value added, higher growth segments of the market in a way that nobody else can do.

That's helpful. And then, Lou, on the cash flow, the collections are extremely good in the quarter. You talked about the linearity. Was there anything -- did, you just have a very large transaction early on the quarter? Is there any more color you can provide on through the strong collections?

No. Just better linearity and good collections.

It wasn't just a few transactions. It was across-the-board better linearity.

Okay. And one more for me, if I could. But a few people have asked about the cash. Maybe I'll try a different angle here, but should we expect any sort of sizable cash outlay for either sort of headquarter expansion or something in that context if you continue to hire?

We are clearly running out of space here, and we do have to do something about it. And that's one of the areas we are exploring, which is a new headquarters. But that's in a exploratory phase. But at the growth rate, if you think about where we are today with, let's call it a -- with consensus, around a $400 million company going to $1 billion, when you get there, and it's going to happen in the relatively near future, then we;ve got to do something about our headquarters.

Your next question comes from the line of Gary Spivak with Noble Financial Group.

Most of my questions have been answered. But I wanted to ask, Bob, to the extent that there are disruptions in supply for disk drives and storage manufacturers, how do we think of that as exposure for you? How much is sold alongside storage and is it actually a positive benefit in that its prices need to now get by with more with what they have?

It's both. Enterprises always have to get by with less, right? And then -- so that -- every enterprise is looking to reduce cost and reduce their spend on storage. So that is underlying demand requirement in the industry. In regard to disk drive shortages, last quarter we saw none. There are some of the storage vendors that are seeing some disruption in disk supply. It has minimal or no impact on us, but it's not 0. There's -- some of the storage suppliers have seen some disruption in supply. But it hasn't affected our ability to hit our objectives. And I think, we're about -- I think we have one more quarter of that and I think we're over it, so.

[Operator Instructions] Your next question comes from the line of Rob Owens with Pacific Crest Securities.

Could you guys give us a little more color on the formation of the ECS practice? And should be view this as normal evolution of the business or has to do more with the increased complexity around Simpana 9 and some of the new functionality or has a lack of pro services been a gating factor in your opinion on driving license growth? And I guess, secondarily, as you look out over the next couple of years, how much should professional services contribute to revenue?

I guess there are several questions in there. Around the Enterprise Consulting Services that we put out there, I think that's primarily a response to more and more activity in the enterprise segment. We wanted to improve our products, products being defined as services offerings here in that environment, get more consultive, get more architectural, get more trusted-adviser-like in our capabilities there. We have the talent. We just needed to develop the programs. I wouldn't say -- I wouldn't necessarily agree with your comment that we've had a lack of PS offerings in the past or that it's impacted or held down any of our growth. Again, it's more a function of the focus into enterprise environments. And we think we're well positioned to take advantage of our position and our capabilities.

I'd add that Al has done a lot of work on just the process of ensuring that our customers have the right solutions to find implemented and managed in the most effective way. And that requires, I'd say, significant upgrades to the resources we apply whether it's solution architects or technical account managers and the way and the process they're deployed. So Al and the team has done a lot of work on this over the past 12 months, understand it, determine what's required and then develop and implement a strategy which we're executing right now. In addition, we've seen large acceleration in our penetration of enterprise accounts. And as Al mentioned, without acceleration, you got to have the resources to make sure that we can service these accounts in a proper way, from upfront design of -- the right solution to solve their core enterprise and data implementation management problems.

Just in terms of overall revenue contribution, is the expectation over the next few years this will remain small or could we see this be 10% type of revenue item 2 years out?

It could be a 10% revenue item 2 years out.

Your next question comes from the line of Joel Fishbein with Lazard.

Sorry, I know you thought you were done with me, but I just have a quick follow-up because I think there's a little bit of confusion over the EPS guidance. I was hoping you that you might be able to help me out. I know you don't give specific guidance, but I think one of the analysts asked you about his math and whether the math is right. But I've done the math a little bit differently, and I can -- doing, coming in -- staying in line with your comments, I can still be at $0.27 for 4Q. And I want to make sure that my math is okay as well.

Yes, I mean, I think what we're saying, Joel, is that the 100 basis point guide implies sequential down. As Lou said, we could do better but we are making big investments, and we think it's a prudent guide. I don't know if that's helpful for you.

Right. Okay. But again, I just wanted -- not to beat a dead horse, but your year-over-year revenue growth assumptions by The Street are roughly 18% year-over-year in Q4. You've always done better in Q4. I know you're up running against tougher comps. You've -- and that implies that even if you take the numbers, the operating -- you spend more money. It's tough to spend that much money in a quarter, but even if you do ramp up the spending that even with the lower operating margin, higher revenue, that you're still going to be flat to up on an EPS basis?

I think, we would -- the implication is flat to down, not flat to up, in terms of the math. . .

At this time, we have no further questions. Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.