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09) Earnings Call Transcript 3 comments

June 02, 2009 | about: BCSI

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Blue Coat Systems, Inc. (BCSI)

F4Q09 Earnings Call

June 2, 2009 5:00 pm ET

Executives

Jane Underwood - Investor Relations

Brian M. NeSmith - President, Chief Executive Officer, Director

Tyler Purvis - Senior Director of Finance

Analysts

Ryan Hutchinson - Lazard Capital Markets

Scott Zeller - Needham & Company

Jonathan Ruykhaver - ThinkEquity Partners

Rohit Chopra - Wedbush Morgan Securities

Daniel Ives - FBR Capital Markets

Alex Kurtz - Merriman Curhan Ford & Co.

Erik Suppiger - Signal Hill Group

Gabe Lowy - Noble Financial

Samuel Wilson - JMP Securities

Douglas Ireland - JMP Securities

Rob Owens - Pacific Crest Securities

Presentation

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Blue Coat systems fiscal fourth quarter results conference call. (Operator Instructions) I would now like to turn the conference over to our host, Ms. Jane Underwood. Please go ahead, Madam.

Jane Underwood

Thank you. Good afternoon and thank you for joining us to discuss Blue Coat's financial results for the fourth quarter of fiscal year 2009. With me on today’s call are Brian NeSmith, our President and Chief Executive Officer, and Tyler Purvis, our Senior Director of Finance.

Before I turn the call over to Brian, let me remind you during the course of this call, we will make forward-looking statements about Blue Coat Systems Inc. and our acquisition of Packeteer Inc. These include statements regarding expectations concerning market growth and business opportunities, including levels of IT spending, expectations regarding future revenues, expenses, margins, profits, tax rates, and other financial metrics, success of our business strategy and changes in our business model and operations, and other matters impacting Blue Coat's financial outlook and future business. All statements other than statements of historical facts are statements that could be deemed forward-looking statements, including any statements of expectation or belief and any statements of assumptions underlying any of the foregoing.

Risks, uncertainties and assumptions include the risks that are described from time to time in reports filed by Blue Coat with the Securities and Exchange Commission, including but not limited to the risks described in Blue Coat's annual report on Form 10-K for the year ended April 30, 2008, and quarterly report on Form 10-Q for the quarter ended January 31, 2009. No assurances can be given that any of these events anticipated by the forward-looking statements will transpire or occur, of if any of them do what impact they will have on the results of operations or financial condition of Blue Coat.

Blue Coat assumes no obligation and does not intend to update these forward-looking statements except as required by applicable law.

Now I would like to turn the call over to Brian.

Brian M. NeSmith

Thanks, Jane. I am in New York City, sitting in a NASDAQ conference room right over Times Square. If the crowds that are any indication of the economy, the mood is actually good here, which is a little bit surprising to me. As for Blue Coat, as you can imagine, we’ve had a hectic few days.

Before I get started with our financial results, I would like to address the underlying reason why we delayed our Q4 earnings call scheduled for last Wednesday, May 27th. As you know, and we recognize revenue from stocking distributors on a sell-through basis and we require them to report shipments that have been made before we recognize the associated revenue. This is done on a point-of-sale or POS report. On the morning of May 27th, we discovered an error in an April point-of-sale report that we had earlier received from one of our European distributors. While the POS report stated that a customer product shipment was made on April 30th, we learned that the product actually shipped in the first week of May. This of course meant that the shipment did not constitute Q4 revenue and that we needed to make required adjustments to our financial statements.

While we believe this to be an isolated incident, learning of this on the morning of our Q4 announcement did not provide us enough time to conduct the necessary reviews, so we had to postpone our earnings announcement while we completed this review.

Over the past few days, our finance team performed an extended review of transactions reported on various distributors’ fourth quarter POS reports. No other errors were discovered.

The summary, the reversal of this transaction negatively impacted our fourth quarter net income on a non-GAAP basis by approximately $280,000. The results we report today reflect this adjustment.

Now let’s turn to our financial results for the fourth quarter. Net revenue for Q4 was $113.6 million, a 4% increase compared to net revenue of $109.6 million in the prior quarter. Excluding net revenue associated with the acquisition of Packeteer, net revenue for fiscal Q4 was $88.7 million, a 3% increase compared to net revenue of $86.4 million in the prior quarter. In fiscal 2009, net revenue was $444.7 million, a 46% increase compared to net revenue of $305.4 million for the fiscal year ended April 30th, 2008. Net revenue excluding revenue associated with Packeteer was $355.6 million, an increase of 16% year over year.

Product revenue for fiscal Q4 was $74.4 million, compared to $72.5 million in the prior quarter. Included in product revenue is revenue from Packet Shaper products, which was $14.9 million, compared to $14.2 million in fiscal Q3. It also included revenue from the Blue Coat Web Filter product, which was $6.5 million, compared to $6.8 million in the prior quarter.

In the fourth quarter, we recognized $39.2 million in service revenue, a $2.1 million increase over the prior quarter. Included in service revenue is $10 million related to former Packeteer product, primarily Packet Shaper, service, and renewals.

On a geographic basis, net revenue in North America was $50.3 million, representing approximately 44% of total revenue. Net revenue in EMEA and Latin America was $42.1 million, representing approximately 37% of total revenue, and net revenue in the Asia-Pacific region was $21.2 million, representing an approximately 19% of total revenue.

Gross margin on a non-GAAP basis increased to 75.3% in fiscal Q4 compared to 75.1% in the prior quarter. On a non-GAAP basis, operating expenses increased approximately $4.4 million to $73.2 million in the fourth quarter. The increase in operating expenses was primarily a result of higher commissions and an increase in headcount across all functional areas of the company.

On a non-GAAP basis, net income for the quarter was $8.4 million, or $0.19 per diluted share. Fully diluted share count for fiscal Q4 was approximately 43.6 million shares.

Turning to the balance sheet, we ended the quarter with cash, restricted cash and investments of approximately $115 million, representing a net positive cash flow of $3.2 million in the quarter, compared to $14 million in the prior quarter. The sequential decline in net positive cash flow was a result of particularly good linearity of bookings and billings in Q3 that resulted in higher cash collections in Q3, contrasted with more typical business linearity in Q4.

Operating cash flow in the fourth quarter was $4.8 million.

Now I would like to turn to my comments to what we are seeing in the market and some highlights from Q4, and discuss how we are currently viewing the business and realigning some of our resources.

Finally, I will conclude with our outlook for fiscal 2010 and guidance for fiscal Q1.

While the current environment is challenging, we are still seeing customers purchase our products to reduce costs, improve productivity, or create more secure networks. Our application delivery network, or ADN-- this I think many of you will see will become a popular three-letter acronym from Blue Coat -- this ADN vision brings us unprecedented levels of visibility, acceleration, and security into a single integrated solution.

About one year ago, we acquired Packeteer and I am pleased to note that we have achieved substantial benefits with added customers, added partners, and added products. During this fiscal year, we also delivered a new release of Proxy SG, a new proxy AV platform, and as well improved malware protection from our Web Pulse cloud service.

While IT budgets remain constrained and customers are generally buying only what they immediately need, we are finding that enterprises are proceeding with projects that deliver a compelling ROI and help drive business productivity while protecting users and critical network assets.

While we saw some signs of stabilization in Q4, the IT spending environment remains uncertain, with no clear sign of when spending will return to normal. Of our three major geographies, North America performed the strongest in the quarter while EMEA was soft. Asia-Pac was the region that was most challenging, especially in Australia and New Zealand. And I think worthy of a special note, Q4 was the first quarter in the last four quarters where we saw a slight improvement in our closure rates.

Given the ongoing economic headwinds in the global market place, I am proud of our team’s accomplishments and how Blue Coat has captured the leadership position in LAN optimization. In fiscal 2009, our customer base expanded by 1,840 customers, with the majority selecting Blue Coat to extend their WAN optimization footprint to the remote branch, offices, and users.

We believe this growth was fueled by Blue Coat's core value proposition, its application delivery network that provides customers with unmatched visibility, acceleration, and security.

When it comes to visibility, we can classify and prioritize over 600 applications with deep layer seven visibility to provide organizations with an accurate picture of network traffic. It remains true that most organizations have no clear picture of what is running on their networks. This visibility can help customers reduce costs and increase business productivity.

In [pure] WAN optimization, we win deals based on our ability to accelerate two key application areas -- secure web applications and video streaming. Our ADN solution accelerates both internally and externally controlled secure web applications and can cache HTPS encrypted objects while maintaining and enforcing an organization’s IT policies. Additionally, our appliances are used in many enterprise networks to accelerate both streaming and video-on-demand applications and can apply both object caching and protocol optimization to optimize the user experience and offload the network and servers.

In security, we win deals based on our fully integrated solution that supports our customer security policies and protects their networks from increasingly sophisticated web-based threats. Our security technologies enable IT managers to keep pace with the continuously evolving spyware, viruses, and malware, and they also provide proactive layers of defense.

Our approach to ADN with its best-in-class visibility, acceleration, and security capabilities, is unique. If imitation is the most sincere form of flattery, our competition has flattered us by adopting and following our ADN vision. They have partnered with other vendors and have acquired companies providing similar but less robust functionality in a piece-meal attempt to address ADN. It is important to note that these multi-vendor solutions are complex and costly to manage, as they require the customer to deploy multiple vendors and boxes. This approach also opens the door to a variety of performance related issues and corresponding finger-pointing. Compare this to Blue Coat's unique and tightly integrated ADN approach, which truly enables our customers to efficiently and cost-effectively optimize and secure the flow of information to distribute users across the extended enterprise.

With the one-year anniversary of the Packeteer acquisition upon us and the integration largely complete, we have been successful in realizing the cost synergies originally anticipated. Additionally, we have substantially expanded our reach by adding approximately 1,000 experienced networking distributors and resellers around the world.

It is worth noting that former Packeteer partners are now more actively reengaged in selling our Packet Shaper product now that the integration is largely behind us, and we have achieved strong success in cross-selling and driving further adoption of both Packet Shaper and Proxy SG appliances.

In the fourth quarter, the number of channel partners selling both our Packet Shaper and Proxy SG products increased by over 30% compared to Q3.

Overall, we have found that our partner community has been highly receptive to broadening their skill sets and offering a richer product portfolio to their customers. From a technology standpoint, Packet Shaper has strengthened our Proxy SG appliance family with its best-in-class application classification engine, rich quality of service capabilities, and traffic management features. These products when deployed together makes Blue Coat an even more strategic vendor to our customers.

Now turning to some product highlights for the fourth quarter, we continue to execute on our vision and strategy for the application delivery network across a number of key product areas. We strengthened our competitive position in the market by introducing version 5.4 of our SGOS operating software for the Proxy SG appliance family. This latest release is designed for fast installation for WAN optimization deployments and features an intelligent configuration wizard that enables set-up and configuration in under a minute.

In Q4 we also introduced our Proxy AV 210 appliance. This is a new low-cost product that enables enterprises to control bandwidth costs and efficiently utilize WAN resources for the delivery of business critical applications.

We view the growing adoption of Web 2.0 and other bandwidth intensive applications as a key growth driver for this product.

We continue to see cyber crime exploiting search engine results and popular websites by injecting links to hidden malware hosts to herd and trap users. Last quarter we introduced dynamic link analysis as part of our cloud-based web pulse community watch defense to detect these malware injections and protect our customers that use our Proxy SG and Proxy Client products.

Being cloud connected means that no download or patches are required and that as new threats are identified, protection is immediately available for the entire Blue Coat community, some 54 million users and growing.

In Q4, Blue Coat also continued to expand and gain new strategic partnership. Of note, we joined the Microsoft System Center Alliance. Through this alliance, we can enhance and support Microsoft System Center configuration manager 2007 and Microsoft Application Virtualization, both of which are part of the Microsoft Desktop Optimization Pack over the WAN to branch offices and over the Internet to remote workers.

Turning to some customer wins in the fourth quarter, in the U.S. the Department of Homeland Security deployed Proxy SG appliances for visibility, acceleration and security, in order to achieve granular management of Internet applications and content. In addition to optimizing the delivery of important content and applications, the Department has successfully reduced its bandwidth consumption by 55%.

In EMEA, we had impressive multi-million dollar wins this past quarter, including sales to [Barclays and to Mobility], the second-largest telecommunications company in the Kingdome of Saudi Arabia.

We recently have made two major changes that will have a positive impact in this new fiscal year. First, we are realigning our sales organization to reflect the different types of customers we sell to. Second, we are changing how we use distribution for product fulfillment by removing stocking rights from all of our distribution partners. Both of these changes should result in improved business efficiencies for us, as well as a better customer experience.

Let’s look at these changes. Previously, we have looked at our sales coverage in terms of the number of sales teams. As a reminder, a sales team consisted of a quota carrying sales rep, a sales engineer, and part of an inside sales person. As of today, viewing our sales force under the old structure, we had 147 sales teams. However, we believe that the sales team model could be improve and as of May 1st, we realigned our sales organization to better serve our diverse customer base and to drive increased productivity.

Our new sales model includes account and territory managers that are focused on strategic large enterprise and mid-tier market customers. We are upgrading the quality and experience of our sales reps, especially of those that are focused on strategic and large accounts. We have hired a number of high caliber professionals from the enterprise and networking industries where solution sales and large enterprise customers predominate. We are also signing our SEs to accounts based on their skill sets and not on a one-to-one pairing with our sales reps, which will better leverage our SEs’ core competencies. We are also using channel account managers to work with our channel partners. This should result in improved coverage for those partners which should equate to greater no-touch revenue from our channel.

As part of this new structure, we have adjusted our sales incentive plan across the sales organization. All of these changes should allow our sales organizations to better capitalize on opportunities in the large enterprise and mid-tier markets where we are particularly well-positioned and ultimately drive greater product revenue growth for the company. We believe we will also see an improvement in sales costs as a percentage of revenue.

As a result of the realignment to our sales organization, we will no longer provide a sales team metric as we will no longer have sales teams as we have traditionally understood. Going forward, we would like to provide better transparency into our business. Often we get asked questions about the split between our WAN optimization and security revenue. Here’s how we view it.

We look at our pure visibility business as Packet Shaper, which contributed $15 million in product revenue in Q4, and our peer security business as Blue Coat Web Filter, which contributed $6.5 million in product revenue in Q4. Based on our analysis of deals, we view the remaining $53 million as our ADN product revenue. We believe this revenue is driven by our customers’ WAN optimization needs plus their need for at least one or both of our key differentiators visibility of security.

Over the last year, Blue Coat has been in the planning stages of developing a new fulfillment model that will eliminate the need for distributors worldwide to stock our inventory. We will be phasing in this new fulfillment model over the next couple of quarters, which will allow us to ship product to customers directly. We believe this new fulfillment model will provide a better customer experience, as well as improve some business efficiencies. It will also eliminate the need for deferred revenue accounting associated with distributor shipments and the need for distributor point-of-sale reporting.

Looking ahead to 2010, I have established three key initiatives for our team. First, we are committed to improving our bottom line performance, increasing our non-GAAP operating profitability. As a result, we will be managing operating expense growth with the growth of our top line. In the past, we have invested heavily in front of our achievement of revenue as we transition our products to the different primary markets that we currently serve.

Today, we are the leader in WAN optimization and secure [web gate] markets with products that are differentiated and well-positioned. Now is the time to drive better leverage in our business model.

Second, we will continue to move forward with our ADN strategy. In fiscal 2010, we will focus our solution roadmap on advancing the integration of the visibility, acceleration, and security technologies at the heart of our application delivery network strategy. We believe ADN competitively differentiates Blue Coat by providing greater value to our customers in an integrated manner throughout our product lines. And third, we will continue to invest in our global advertising campaign and thought leadership program surrounding our ADN vision and strategy to establish brand awareness higher in the value chain. Underlying our marketing investments will be a host of sales and channel enablement programs and promotions.

Now turning to our guidance for the first quarter of fiscal 2010 -- we currently anticipate net revenue in the range of $114 million to $119 million. On a non-GAAP basis, EPS is expected to be between $0.20 and $0.25 per diluted share, which assumes a diluted share count of approximately $44.5 million. For planning purposes, we are using a 30% tax rate for fiscal 2010.

With that, I would now like to turn the call over to Jane.

Jane Underwood

Thank you, Brian, and that concludes today’s prepared remarks. Greg, we would now like to open up the call for analyst questions.

Question-and-Answer Session

Operator

(Operator Instructions) First we go to the line of Ryan Hutchinson with Lazard Capital Markets. Please go ahead.

Ryan Hutchinson - Lazard Capital Markets

You gave some color on the bottom line as it relates to the rev rec. Could you just provide what the impact was to the top line?

Brian M. NeSmith

I’ll actually ask Tyler. I don’t think it was that significant but Tyler, can you actually expand on that?

Tyler Purvis

Top-line impact was $550,000.

Ryan Hutchinson - Lazard Capital Markets

Okay, great. And in the confidence level moving forward here that this is not going to string into a series of events, I know you touched on it in the call but pretty extensive over the weekend and --

Brian M. NeSmith

Yeah, we thought that morning, as when these things typically happen, we believe it was an isolated incident. The problem you have is that when something like that occurs, you need to go through a fairly exhaustive review of a lot of things and we didn’t find any other errors, so it’s I think an isolated incident. I don’t expect a repeat of that but because it’s an isolated incident, you can’t predict exactly when it’s going to happen but I don’t see any indication of any systemic problem or behavior issues.

Ryan Hutchinson - Lazard Capital Markets

Okay, and then one follow-up -- you touched on it as well. I mean, it seems like you’ve got a lot of initiatives here in the new fiscal year but there was an 8-K filing talking about your profit sharing plan and in it you outline the payments that could be made under the plan for the fiscal quarters in which the operating profit exceeded 15%, so I’m just trying to understand how we should be thinking about that. It seems like there’s some discipline here on the operating margin front and when I look at and tie that to the guidance and the operating expenses, assuming sort of at the midpoint, it does imply that OpEx is going to be flat to down, so I just want to get your view on how you are looking at that for the specific give quarter, upcoming quarter as well as the remainder of the fiscal year, and that’s it for me, thanks.

Brian M. NeSmith

Yeah, I don’t -- the guidance I think from when you look at the EPS guidance and you work backwards to that piece, I think it’s flat to -- I would have said operating expenses as a percent of total, probably flat to slightly up in that picture. I think the one thing that’s worth noting, that’s obviously the guidance for the next quarter. What we were trying to highlight for the fiscal year is that we as a company have struggled through multiple market product transitions and in each phase of those growths, it sometimes takes several years to work your way through that and what we are highlighting is that we think we are in a very strong competitive position in both of the main markets that we plan and we are at a point that we think we can achieve better operating leverage as we go forward, and that thematically is clearly going to be true I think as we go through this fiscal year.

Ryan Hutchinson - Lazard Capital Markets

Okay, great.

Operator

Next we turn to the line of Scott Zeller with Needham & Company.

Scott Zeller - Needham & Company

Thanks. I want to ask about the rev rec issue. Could you tell us when you did your investigation, did you look at the transactions for the single distributor involved, or did you look at other distributors? And what was the timeframe that you investigated? Was it only the current just completed quarter or did you go further back?

Brian M. NeSmith

I’ll ask Tyler to expand upon that -- I know the answer but I think he can probably provide better detail.

Tyler Purvis

Yes, we looked at distributors -- various distributors within the region. We focused on the current quarter although we did do a sampling of large transactions back in prior quarters as well, just to ensure we had comfort over the numbers as presented.

Scott Zeller - Needham & Company

Okay, and could you tell us, Brian, an update on when you last spoke on the previous earnings call, you talked about the material size, Packeteer channel partners. I think you had mentioned there were roughly 30 of them that were material in size and you had mentioned that somewhere around nine or 10 of them had been brought on to also selling Blue Coat.

I mean, I did get the metrics that you shared. You said 30% up overall for all channel partners selling both solutions but how about the largest Packeteer people, just a rough progress report on that?

Brian M. NeSmith

You know, I don’t know the exact numbers. What I can tell you is that we are seeing synergies between both -- selling of both products and it’s true with our partners but also true of the products and our partners are starting to recognize that as well. We definitely are starting to see even historical Blue Coat partners realizing opportunities with Packet Shaper. We’re seeing historical Packeteer partners seeing a lot of opportunity of selling both and there’s a bit of confusion right after the acquisition where people weren’t even sure exactly where they were going to end up. But I think generally now we are settling down and we are finding that the partners that we really wanted to keep and wanted to leverage are really fully engaging in the process here. So I’m actually pretty bullish on the activity we have going with that partner channel and the investments we’ve made in that channel and also in helping drive leverage in our operating model as we go forward.

Scott Zeller - Needham & Company

Thank you.

Operator

Next we turn to the line of Jonathan Ruykhaver with ThinkEquity Partners.