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Executives

Tom Reilly - President & Chief Executive Officer

Stewart Grierson - Chief Financial Officer

Rob Dougherty - FD

Analysts

Robert Breza - RBC Capital Markets

Keith Weiss - Morgan Stanley

Scott Zeller - Needham & Co.

Craig Nankervis - First Analysis

Jonathan Ruykhaver - ThinkEquity

Philip Rueppel - Wells Fargo Securities.

Israel Hernandez - Barclays Capital

Erik Suppiger - Signal Hill

Jay Meier - Feltl & Co.

ArcSight, Inc. (ARST) F1Q10 Earnings Call September 3, 2009 12:00 PM ET

Operator

Good day and welcome to the ArcSight first quarter 2010 financial results conference call. Today’s conference is being recorded. At this time I’d like to turn the conference over to Mr. Rob Dougherty with FD. Please go ahead, sir.

Rob Dougherty

Thanks very much. Hello and thanks for joining us today for the ArcSight first quarter fiscal 2010 conference call. On the call today are Tom Reilly, President and CEO, and Stewart Grierson, CFO of ArcSight.

During the course of this call, we will make forward-looking statements regarding future events and the future financial performance of the company. Generally, these statements are identified by the use of words such as expect, believe, anticipate, intend, and other words that denote future events.

These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. We caution you to consider the important risk factors that could cause actual results to differ materially from those in the forward-looking statements in the press release and on this conference call.

These risk factors are described in our press release and are more fully detailed under the caption risk factors in the ArcSight Annual Report on Form 10-K as filed with the SEC on July 9, 2009 and in the company’s other filings with the SEC. During this call, we will present both GAAP and non-GAAP financial measures.

Non-GAAP measures exclude amortization of intangibles and stock-based compensation expense. These non-GAAP measures are not intended to be considered in isolation from, a substitute for or superior to our GAAP results and we encourage you to consider all measures when analyzing ArcSight’s performance.

For complete information regarding our non-GAAP financial information, the most directly comparable GAAP measures and a quantitative reconciliation of those figures, please refer to today’s press release regarding our first quarter fiscal 2010 results. The press release has also been furnished to the SEC as a part of a Form 8-K.

In addition please note that the date of this conference call is September 3, 2009 and any forward-looking statements that we make today are based on assumptions that we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of new information or future events.

Lastly, this conference call is the property of ArcSight and any recording, reproduction, or rebroadcast of this conference call without the express written permission of ArcSight is strictly prohibited.

Now I will turn the call over to Tom Reilly, President and CEO of ArcSight.

Tom Reilly

Thank you, Rob. My special thanks to the investors, partners, customers, and team members joining us for today’s earnings report. I am pleased to share that ArcSight had another strong quarter of performance. We exceed expectations in revenue, net income, and earnings per share.

Total revenue for the first quarter of fiscal 2010 was $34.6 million a 25% year-over-year increase. Non-GAAP net income for the quarter was $3.2 million or $0.09 per diluted share. We generated $9 million in cash from operations and closed the first quarter with cash and cash equivalents of $101.5 million.

Our strong results this past quarter can be attributed to the fact that cyber threats are becoming increasingly sophisticated. They are occurring more frequently and the financial rewards for the perpetrators are growing. With global connectivity accelerating, nearly every business and government organization worldwide is exposed and acceptable to significant risk and they are therefore making the necessary investments to protect themselves.

I like to classify cyber threats into four categories. The first category is cyber-fraud of financial accounts. This typically involves phishing attacks, account takeovers or other attempts to steal money by compromising user credentials in order to access financial systems.

The sheer number of phishing attacks on the rise and today every unsolicited e-mail, attachments or link sent to unsuspecting employees, partners and customers oppose a serious risk of a security breach. According to a study performed by CSI, the average reported cost for cyber-fraud is estimated close to $500,000.

The second category is cyber-theft of personally identifiable information. The theft of identity data is highly rewarding and increasingly we’re seeing very sophisticated and well funded crime rings targeting corporations and government agencies in attempts to steal large amounts of credit card data, health records, social security numbers, passport information and now, even digitized fingerprints.

In a recent study conducted by Verizon, nine of every 10 records breached in 2008 were related to organized crime. The third category is cyber-espionage of sensitive information. This type of threat involves attempts to access confidential assets, such as intellectual property, product designs, contracts or undisclosed financial data from publicly traded companies. The Office of the U.S. Trade Representative reported that intellectual property theft alone costs American corporations $250 billion every year.

Finally, the fourth category, and the one of greatest potential for harm, is cyber-warfare arising from attacks conducted by enemy nation states on the critical infrastructure and services of other countries. These well planned and complex cyber attacks target telecommunication networks, utilities, transportation systems, oil and gas pipelines, refineries, and financial service firms. It was estimated by the U.S. Cyber Consequences Unit that a single wave of cyber attacks on critical infrastructure could exceed $700 billion in losses, the equivalent of 50 major hurricanes hitting the U.S.

Across these four categories, whether cyber-fraud, cyber-theft, cyber-espionage, or cyber-warfare, we’re seeing the attacks of perpetrators becoming more determined, more skillful, and more organized. To help illustrate the impact these various threats, one need look further than recent headlines. Last month, the popular sites Twitter and Facebook are victims of denial-of-service attacks. This was the second time in two months that Twitter has been the target of cyber attacks.

In July, hackers infiltrated the personal Google accounts of key Twitter employees, stole personal information and company financial reports, and posted them online. In early July, hacker controlled botnets, infecting over 50,000 computers, proceeded to overwhelm and immobilize a number of South Korean and U.S. government online operations.

The websites of the U.S. Treasury Department, Secret Service, Federal Trade Commission, and Transportation Department were all affected, as were the websites of South Korea’s Presidential Blue House, Defense Ministry, and National Assembly, to name just a few.

At a congressional hearing this past month, it was reported that inadvertent file sharing over P2P networks resulted in confidential files being discovered on file sharing networks. These included the location of the Secret Service safe house for the first lady, the Social Security numbers of every master sergeant in the Army, medical records of some 24,000 patients of a Texas hospital, and the entire outlook calendar of an individual who handles merger and acquisition activity at a well known, publicly traded company, including attachments detailing every proposed deal.

This past month, it was reported in many major newspapers that federal prosecutors had charged a Florida resident with wire fraud and conspiracy for allegedly stealing data from nearly 130 million credit and debit card accounts from such retail chains as TJ Maxx, Marshalls, Barnes & Noble, and OfficeMax. This very same suspect was already awaiting trial for charges of having previously stolen data related to 40 million credit cards. All of these security breach news events have occurred since our last earnings call.

I would now like to share a new announcement from this very morning. Today, Information Security magazine reported that the ArcSight’s ESM and longer platform was awarded the reader’s choice award for the best security information and event management product. We were recognized specifically for our own robust event correlation capabilities, as well as the effectiveness of our dashboards, our data archiving capabilities, and policy engine.

I would now like to discuss our strategy to leverage this award winning platform in growing our business by helping our customers protect their businesses from cyber-attacks. If you will recall from our last earnings call, we have three growth strategies for our current fiscal year. To review, first, we’ll focus relentlessly on our customer success, which results in significant repeat purchases each quarter from our installed base.

Second, we’ll pursue new high value opportunities by leveraging our platform for enterprise wide threat and risk monitoring. Third, we’ll expand our market reach by aggressively pursuing the mid-market with our channel partners. Our success in executing against these three strategies will allow us to achieve our growth objectives and will provide the framework for how you should evaluate our performance going forward.

I will now share a brief update on each of these. Our first strategy of focusing on customer success pays great dividends. Our product depth and our customers’ evolving security and compliance needs have enabled us to grow consistently within our installed base. This past quarter was no exception, as 59% of our product revenue came from existing customers.

This consistency of repeat business is reaffirmed by the fact that over a five year plus period, our customers on average nearly triple their original purchase. Our second strategy is to pursue new high value opportunities by introducing innovative capabilities that leverage our platform for enterprise threat and risk monitoring across all components of the IT stack from the perimeter, network right up through business applications and users and then out into the cloud.

Our Identity View product for role-based monitoring and our fraud prevention solutions are two examples of recent offerings in new high value areas. Today, we not only monitor a customer’s IT perimeter for external attacks, we also monitor inside of threats, privileged user activity, sensitive data access, separation of duties and the integrity of critical transactions.

I’d like to share with you a customer example from this past quarter that not only illustrates the importance of our platform to enable broad enterprise threat and risk monitoring, but also our ability to generate additional revenue from our installed-based. One of our financial service customers made their first purchase of ArcSight in fiscal 2006 for an initial order of $100,000.

Following the success of that first deployment, that same customer subsequently purchased an additional $1 million over the next three years. Recently this customer decided to leverage ArcSight even further as their platform for enterprise threat and risk monitoring.

They are now expanding their deployment to include correlation events from their database activity monitoring solution, in order to track privileged users with access to highly sensitive information. This recent extension of our platform resulted in a new purchase of $500,000 this past quarter, bringing their cumulative purchases with us to $1.6 million or 16 times their original purchase amount.

Even after all this expansion, we still see significant opportunities going forward with this client, as we help them address their evolving enterprise threat and risk monitoring needs. Our third strategy is to extend further into the mid-market by primarily selling compliance based appliance solutions through our partner community. We are extremely fortunate to work with the best value-added resellers in the business.

For example, this past quarter one of our channel partners sourced an opportunity with a mid-sized retailer that needed to achieve PCI compliance quickly. After an online WebEx demo of our PCI log management solution, the customer elected to move forward with us.

This was a competitive win, and reflects the leverage we get from our channel since, in this case, there was no involvement from our direct sales force and we received a purchase order for just over $75,000 within 30 days from the initial interaction with the customer.

With data privacy laws and compliance mandates being introduced in many countries and across verticals, we feel we have only scratched the surface of the large mid-market opportunity with our partners. Our execution against our three growth strategies is delivering positive results. Our strong performance and outlook gives us the confidence to continue hiring into the organization.

This past quarter, we added 33 new team members, bringing our total employee count to 433 at the end of July. We recently announced the appointment of Joni Kahn as our new Senior VP of Worldwide Services and Support. She’ll be responsible for overseeing professional services, customer support, training and partner enablement.

Joni brings to us extensive experience, having managed large global service operations at BearingPoint, Business Objects and KPMG. Joni’s hire reflects our ongoing commitment to customer success. In addition, we recently announced the appointment of Matt Hynes as our new VP of Worldwide Channels.

Matt brings 20 years of security related channel and selling skills to ArcSight after leading similar programs at McAfee, Panda Security, nCipher, and e-Security. We are very pleased with the enthusiastic support we are receiving from our partners relative to Matt’s announcement.

Matt’s hire reflects our continued commitment to our partners and the pursuit of growth in the mid-market. So these are some of the strides we’ve made against our growth strategy. I’d now like to discuss how these investments have garnered traction in the marketplace. We continue to see strong demand in the government sector.

For the first fiscal quarter, government accounted for 37% of our business, compared to 25% in the prior year. Our federal business remains strong, with cyber-security getting significant attention from the highest levels in Washington. Our performance across verticals is well balanced and inline with our expectations. In addition to government, our top contributing verticals were financial services and telco at 18% and 10%, respectively.

From a geographic perspective, we are pleased with the consistency of results in North America, where product revenue increased by 27% on a year-over-year basis. Elsewhere, we are beginning to see pockets of stabilization on spending where there had been significant softness earlier. In particular, based on Q1 performance and our current outlook, we believe we’re seeing a bottoming, possibly even signs of recovery in the EMEA region, the geography that’s been relatively weak in the prior few quarters.

Our APAC region did not perform as well as we had hoped. This is partially attributable to a continued weak economy in this broad region, and we also feel there have been some areas where we haven’t executed effectively. We’ll soon be announcing a new regional manager for the Australia and New Zealand markets, as well as a new Vice President of Sales for the Japan market.

Before turning over the call to Stewart, I would like to add that we are gearing up for our fifth annual user conference called Protect ‘09, to be held this month in Washington, D.C. This year, we expect record attendance in excess of 600 attendees, with over 25 customer led presentations on best practices. There will also be roughly 30 ISV partners demonstrating how their solutions extend our platform and the platforms of our customers and we also have a high powered line up of industry and government executives as keynote speakers.

I’m pleased to announce that we’ll be presenting at a number of investor conferences in the coming months, including the Deutsche Bank and ThinkEquity investor conferences in San Francisco on September 15 and 16, as well as the William Blair conference in New York on October 6. Lastly, we are very excited to be hosting our first investor and financial analyst day in New York on October 13. We’ll provide more information about this event as we get closer to the date.

I’d now like to turn the call over to Stewart to discuss our financials in greater detail. Stewart.

Stewart Grierson

Thanks, Tom. As previously mentioned, for the first quarter ended July 31, 2009, we had total revenues of $34.6 million, representing year-over-year growth of 25%. We recorded non-GAAP net income of $3.2 million or $0.09 per diluted share, excluding stock based compensation expense of $1.9 million and amortization of intangibles of $0.2 million. This represents significant year-over-year growth compared to non-GAAP net income in the prior year quarter of $0.3 million or $0.01 per diluted share, excluding stock based compensation expense of $1.4 million and amortization of intangibles of $0.2 million.

We recorded GAAP net income of $1 million or $0.03 per diluted share versus a loss of $1.3 million or negative $0.04 per diluted share in the prior year quarter. In the first quarter, we generated 59% of our product revenue from our existing customers. Our installed base continues to be a key driver for our revenue growth, as our existing customers expand the deployment of our products within their IT infrastructure, including extending the platform to new use cases. We added 35 new customers in the quarter, representing 41% of product revenue.

While the number of new customers is lower than the last several quarters, this was primarily due to a significant reduction in new customer wins in APAC. Given the transaction sizes in APAC are smaller this decline in customer wins did not have a significant impact on our revenue from new customers. We did not have any customers that contributed more than 10% of revenue in the quarter. On a non-GAAP basis, gross margin for the quarter was 82%. Appliances contributed 41% of total product revenue in the quarter.

As discussed on previous calls, our gross margin has stabilized in the low 80% range, which is consistent with our long-term model. Non-GAAP operating costs for the quarter were $24.5 million, which is a $1.5 million decrease from Q4, primarily driven by lower variable compensation costs. G&A expenses were impacted by approximately $500,000 of legal costs associated with a potential small technology asset purchase, which we decided not to pursue and activity related to ordinary course litigation, which has been settled.

We generated a Q1 non-GAAP operating margin of $3.8 million or 11% of revenue. As Tom mentioned, we added 33 employees in the first quarter. We are continuing to hire to deliver on our growth strategies and have already added an additional 20 employees in Q2, to bring our current headcount to an excess of 450 employees. As a result, we expect both R&D and sales and marketing costs to increase in Q2, while G&A should decline marginally.

Turning to the balance sheet, we ended the first quarter with cash and cash equivalents of $101.5 million, an increase of $11 million from the prior quarter. We generated $9 million in cash from operations and $3.2 million from financing activities, driven by proceeds from the exercise of stock options.

We used roughly $1.3 million in capital expenditures. As discussed on our last earnings call we expect capital expenditures to be significantly higher in fiscal 2010 as we implement new enterprise business systems. In accordance with GAAP and as discussed on prior calls, we net down accounts receivable and deferred revenue for sales transactions that are recognized on a cash basis.

For clarity, these cash basis transactions are sales transactions generally through new partners without established credit that occur within the quarter, but will only be recognized as revenue in future periods when we collect the cash. As a result, in order to understand the change in accounts receivable and deferred revenue from period-to-period, one must take the impact of the net down into consideration.

Deferred revenue of $41.8 million at July 31, 2009 was net of $8.6 million of cash basis transactions. This compares to fourth quarter deferred revenue of $45 million that was net of $9.1 million of cash basis transactions. As a result, gross deferred revenue decreased by approximately $3.7 million from the fourth quarter of fiscal 2009 to the first quarter of fiscal 2010.

On a sequential basis, gross product deferred revenue decreased by $2.2 million, while gross maintenance and service deferred revenue combined decreased by $1.5 million. Accounts receivable was $23.1 million at July 31, 2009, compared to $34.2 million at the end of the fourth quarter.

Once again, both these balances are net of $8.6 million and $9.1 million, respectively, for cash basis transactions. Our DSOs for the quarter was 62 days, which is inline with our stated target of 60 days to 70 days.

I will now provide guidance for the second quarter of fiscal 2010. Based on current visibility, particularly with regards to our federal business, we expect revenue for the second quarter of fiscal 2010 to be in the range of $38.5 million to $42.5 million, which represents growth of 17% to 30% over the prior year.

We expect non-GAAP net income for the second quarter of fiscal 2010 to be in the range of $3.5 million to $4.9 million or $0.10 to $0.14 per diluted share, excluding stock-based compensation expense and amortization of intangibles.

I will now turn the call back over to Tom to provide his concluding remarks.

Tom Reilly

Thank you, Stewart. In summary, the world is experiencing a rise in cyber attacks, whether it’s cyber-fraud of financial accounts, cyber-theft of identities, cyber-espionage of confidential information, or cyber-warfare on critical infrastructure.

ArcSight is very pleased to be a provider of technologies and services that help corporations and government organizations defend and protect their business from these attacks. We believe our three growth strategies properly account for these increasing threats and that we’re well positioned for continued success.

This concludes our prepared comments for today. We will now take your questions, please.

Question-and-Answer Session

Operator

(Operator Instructions).Your first question comes from Robert Breza - RBC Capital Markets.

Robert Breza - RBC Capital Markets

Tom, as you looked and talked about the growth strategies, can you kind of help us how you think about maybe the remainder of the year and think about what will likely happen between the percentage of contribution from the installed base versus maybe that the new customers you talked about maybe seeing a slight recovery and should we expect that the percentage to change much through the year or do you think it’s going to stay status until we get the evidence of the recovery and then, Stewart maybe a quick question for you. Can you help us understand the tax rate and how we should think about that for the rest of the year?

Tom Reilly

So, Rob I think every quarter will see fluctuation of the revenue coming from our installed-based versus revenue coming from net new customers. As the channel continues to ramp up and they get more skills that should be reflected in more new customers coming out of the mid-market, so the customer count goes up.

As we further penetrate even further down into the market, some of those price points are lower. So then, a lot of our revenue from the installed base, now it comes from customers incrementally expanding their projects, but then we always have the variability of any given quarter, a customer that completely signs up for our enterprise threat and risk monitoring strategy and is looking to make some significant investments. So it will vary from quarter-to-quarter and that’s why we have two separate strategies.

One is to focus on our customers, their success, which allows them to expand their projects. The second is to introduce new things to them, so we continue to sell them more things and make them more secure, but thirdly leveraging our channel partners for more customers.

Stewart Grierson

Rob, on tax rate based on our current view, I think 38% is the right rate for you to use. Obviously, that can fluctuate from quarter-to-quarter. As I talked about on the last call, the biggest impact to that is exercise of stock options within the quarter and what that does to your tax rate, but I think 38% is a reasonable rate to use.

Robert Breza - RBC Capital Markets

Maybe, Tom just one follow-up, as you think about the new customers coming on, and obviously you guys are expanding your portfolio from a new products perspective, should we see the initial ASP change much from historical trend or how would you kind of talk us through what a new customer, new deal size looks like or maybe how that should evolve over the next 12 months to 18 months?

Tom Reilly

So I’d answer it this way. We’ve been expecting, as we move down market, that we might see our initial ASPs go down. In fact, they’ve been holding quite steady. So that’s been, I think, a favorable thing that we’re seeing, but as we go into a lot of our new deals we’re pursuing are compliance driven, point solutions to solve that specific problem maybe within a department or solve one problem for a company.

So we’re trying to continually solve that through an appliance oriented, easy-to-deploy solution specifically built for that, and those initial ASPs would traditionally be lower than what we would experience from a broader kind of deployment. We expect each of those customers to represent the same type of long term opportunity once they get past that initial success.

Operator

Your next question comes from Keith Weiss - Morgan Stanley.

Keith Weiss - Morgan Stanley

First I wanted to ask you guys about on guidance. At this point in your guidance, the revenue growth at least sustaining at the high end of your guidance, you have your revenue growth actually accelerating into next quarter. Could you give us some sense of what gives you the comfort for what appears to be very nicely robust growth in your guidance outlook?

Tom Reilly

This is Tom. One of the nuances of our Q2 is that we had the federal sector close at the end of September and so at this point of doing a call and giving guidance, we have more visibility at least with what’s coming in September versus sitting back in Q1. We knew that more of our business was further out in the last month of the quarter.

Keith Weiss - Morgan Stanley

Then on the express product, I was wondering if you could give us an update on how the traction in that product has been going?

Tom Reilly

While we don’t break it out separately, we’re very pleased with the receptivity of that, not only by the end customers, but also by the partner channel, so the adoption is strong.

Keith Weiss - Morgan Stanley

Then to sort of add on to one of the last questions that Robert added. Have you guys seen any initial success and being able to expand some of these more point implementations that you’ve been seeing recently across some of the more appliance driven implementations into a broader framework or has most of that up sell activity taken place in the more traditional software based customers that are in your base?

Stewart Grierson

Keith, this is Stewart. So Tom talked earlier in his prepared remarks about the follow-on business from our existing customers and typically, when we’re looking at that, we’re talking about our enterprise customers and obviously, the mid-market is a newer market for us where we have less experience, but based on the early data so far, we do see up sell opportunities within those mid-market customers as they will expand the scope. I don’t think it’s to the same degree of significance we’ve seen at the enterprise, but there has been up sell opportunities in those accounts.

Operator

Your next question comes from Scott Zeller - Needham & Co.

Scott Zeller - Needham & Co.

Regarding the federal or public sector, we’ve heard of several pilots that had gotten underway, obviously a strong vertical for you, but can you tell us specifically for some of the pilots that have gotten off the ground, are a lot of them actually converting right now or do we still have quite a few of them out there that could convert into large opportunities down the road?

Tom Reilly

Well, it’s a nuance of government by technology. Their pilots, quite frankly look like real projects in the commercial world. What a pilot in the government sector is they deploy technology in these very sophisticated labs and operate them. To us those pilots look like an end project, but then, the real opportunity is when those into the production environment they’re very large environment. So, we’ve been seeing a number of those pilots underway. They last for long periods of time until funding through. So Scott, I hope that helps answer it and gives you a little sense of how these pilots work in the government.

Scott Zeller - Needham & Co.

Next, can you help us again and review what your expectations are for seasonality going forward through the rest of the fiscal year?

Stewart Grierson

I don’t think we would expect to see any real change in our quarterly seasonality and obviously in Q2, we have historically gotten the benefits from the federal fiscal year end, as Tom talked about, at the end of September, but there is nothing to lead us to expect that there is anything else different from a seasonality perspective.

Operator

Your next question comes from Craig Nankervis - First Analysis.

Craig Nankervis - First Analysis

Tom, for you how about the overseas government contribution has that picked up or has your outlook perhaps changed incrementally since 90 days ago maybe we’d start there.

Tom Reilly

More activity in overseas government as a matter of fact, rather than being opportunistic around that sector internationally, we are more proactive. So, we’re actually we’re mapping up governments and government agencies, looking at our coverage around those and not every all 200 governments of the world, but the specific ones where we think they have some opportunity. So we see that as a significant opportunity going forward.

Craig Nankervis - First Analysis

So it remains more opportunity, so the 37% of product that was from the government was not necessarily influenced much by overseas activity. Is that a fair statement?

Tom Reilly

Yes. While that includes all governments, it’s primarily the federal government.

Craig Nankervis - First Analysis

Then, I know you touched on fraud. Can you just discuss qualitatively how the fraud opportunity or pipeline has changed for you? Is that growing as a driver or sort of staying steady as a driver?

Tom Reilly

It’s growing as a driver. One of the things around fraud is much more than having a good technology solution, we’ve really just had to learn as a selling organization to build up skills around that and work with the early customers and so I think a lot of that learning is getting reflected in our pipeline in opportunities going forward.

So we move from talking to security experts, really getting involved with fraud experts. So we see it as a growing pipeline and an interesting area for us that kind of move us up the IT stack. In the fraud space, we start needing to understand application language.

Craig Nankervis - First Analysis

Also for Tom, sort of piggybacking on the last questioner and the seasonality throughout the year, should we take the Q2 revenue guidance as a spike of sorts because of your visibility in federal or are you willing to say whether the range you’re providing is somewhat of a sustainable trend?

Stewart Grierson

Obviously, we didn’t give fiscal guidance and so, I think the Q2 guidance reflects the visibility we have as of this point in Q2 and obviously, as we commented on, we certainly have near term visibility to the government spend that’s going to impact the current quarter, because it’s likely going to happen mostly this month.

Craig Nankervis - First Analysis

Then, Stewart maintenance revenue jumped sequentially, but I think the highest amount it has ever jumped sequentially. Why was it so high and how do we think about that in Q2? Where that maybe comes out?

Stewart Grierson

That’s really attributed to timing. So I think in the current environment what we’re seeing is on the maintenance renewal side, although our rates are still above 95%, what you’re seeing is a slower renewal rate, if you will, when people are pushing that somewhat and so in Q1, we certainly got some benefit there from some catch up.

I think if you look at, for example, deferred maintenance revenue at the end of Q1, you’re seeing it slightly lower and you’re seeing that same thing, where people are trying to push out renewals as a result of the environment and so, it’s purely a timing issue is the way to look at it.

Craig Nankervis - First Analysis

So it’s going to normalize somewhat in a sequential movement as we go to the second quarter.

Stewart Grierson

I think it will normalize even more so to the extent that we continue to see recovery and we get some maintenance renewals back on a more timely basis.

Craig Nankervis - First Analysis

Lastly, did you give overseas as a percent of revenue and then, secondly, APAC as a percent of revenue this year versus maybe a year ago, do you have that?

Stewart Grierson

We didn’t give it, but I’ll give it to you. So, basically outside of Americas, so EMEA and APAC was 17% of the quarter, compared to 22% a year ago and as Tom mentioned, we’re not happy with our performance in APAC. You saw revenue down year-over-year in that region.

Operator

Your next question comes from Jonathan Ruykhaver - ThinkEquity.

Jonathan Ruykhaver - ThinkEquity

I’m just trying to reconcile your comments around solid initial activity with Express and then the decline in sales of appliances as a percent of revenue. Did you see a falloff in Logger or ESM?

Stewart Grierson

I’ll clarify Tom’s comments and so while Express wasn’t meaningful from a revenue perspective in the quarter, we’re certainly seeing very good interests for Express and so, it’s not an Express related item.

Jonathan Ruykhaver - ThinkEquity

Did the introduction of Express dampen activity for Logger or ESM?

Stewart Grierson

No.

Jonathan Ruykhaver - ThinkEquity

So that’s just a slower growth relative to what you saw within probably other higher end ESM software customers?

Stewart Grierson

It’s just mix, correct.

Jonathan Ruykhaver - ThinkEquity

Then, I think you’ve disclosed in the past about 40% of sales is what goes through your channel. Is that still the number that you’re seeing?

Stewart Grierson

Very consistent, yes.

Jonathan Ruykhaver - ThinkEquity

I am curious, how do you feel about direct pull from your channel partners at this point? Are you seeing that or is it still too early for that to take place?

Stewart Grierson

I think it’s still largely fulfillment, but I think Tom gave a good example of where we’re starting to see with some of our partners who perhaps a little more mature and working with us, typically with our Logger product of them being able to generate more pull, but obviously, as we’ve talked about previously, that is something that we are continuing to work on and we have a big emphasis around partner enablement and it’s one of our key growth strategies for the year.

Jonathan Ruykhaver - ThinkEquity

Can you talk a little bit in detail around some of the programs, maybe new training or certification that you’ve put in place to drive that?

Tom Reilly

If you recall, we talked about it. On the last call, we actually have applied resources this year in our training organization specifically targeted at our partners. To provide dedicated training to that group. Not only on a sales training perspective, but also then, on implementation services and as well as the other thing that we have been doing from a resource perspective is applying more SC or technical type resources focused on the channel.

Jonathan Ruykhaver - ThinkEquity

Where would you expect those initiatives to start to drive greater channel productivity?

Tom Reilly

Certainly, we’d love to, whether we see much change in the back half of this year, it’s hard to tell. These things do move slowly and you’ve got to have some patience. I would think we’d see it towards the back half of this year, if not next year, we’ll see a little more pull.

Jonathan Ruykhaver - ThinkEquity

Then just final question, can you talk a little bit about the partnership with Cisco, the integration of that Cisco Mobility Service into ESM? I’m trying to understand from a data location point of view, how is that capability important and when will that integration being complete?

Tom Reilly

Integrations complete. The importance of that capability is, as traditional perimeters breakdown and effectively enterprise as a perimeter goes away, one of those breakdowns is more and more of your employees on mobile devices and PDAs and over wireless networks. Then we realized that it’s no longer about monitoring the perimeter. You actually have to monitor the users and their activity and what systems they’re accessing.

So, it’s very difficult to monitor a mobile user, especially as they move across your wireless network and they transfer from one antenna to another antenna, whatnot. So our partnership with Cisco is to enable that monitoring of users as they move across the network. They’ve been able to correlate these things and follow a user based on their roles and entitlements.

So it’s part of our enterprise use strategy, which basically says, as the perimeter goes away, it’s no longer about monitoring the perimeter, it’s actually about monitoring users, vis-a-vis their roles and entitlements, and what applications and what sensitive data are they accessing, and are they actually who they are supposed to be.

Jonathan Ruykhaver - ThinkEquity

Tom, have you sold any use cases around that functionality yet?

Tom Reilly

I don’t know the answer to that, actually, sorry. I know that we introduced that to a lot of our customers. In many cases, that is the differentiating capability, when a customer sees our vision and some of our capabilities there. Whether they deploy that into production, I’m not sure, but I myself am getting quite astute talking with customers and prospects about it.

Jonathan Ruykhaver - ThinkEquity

Then just final question on that partnership; is there any opportunity to leverage that Cisco channel overtime? Or does that not included in this agreement?

Tom Reilly

That’s not included in this agreement. Is there opportunity there? Yes, but I think that’s not something we’re counting on.

Operator

Your next question comes from Philip Rueppel - Wells Fargo Securities.

Philip Rueppel - Wells Fargo Securities

On the hiring, the 33 new last quarter and 20 new this quarter, was that similar to the last couple of quarters, primarily in sales and marketing? Or was it more broadly across the company?

Stewart Grierson

So the first quarter, hiring the 33 people was primarily sales and marketing, but also a fair amount of R&D hiring. As we’ve gone into Q2, that is less about sales and marketing. If you recall, we do most of that hiring in the first quarter of our fiscal year. That is more focused more broadly across the rest of the organization.

Philip Rueppel - Wells Fargo Securities

Regarding the sales force, have you seen more turnover than you have in the past? Have you started to see some of the sales force that you hired last year become more productive? I guess, was this a typical Q1 or was there sort of more pronounced changes to things like territories and the like?

Tom Reilly

It was a very typical Q1. We’re bringing on a lot of new folks for the fiscal year. Basically, our whole strategy is to hire our sales force for the full year, so we don’t cut territories midway through the year. So we, right on time, got all our territories out there, got our folks retraining. We’re consistently seeing it takes about five months to ramp up our new people and for them to get productive. So we are tracking well.

Philip Rueppel - Wells Fargo Securities

Then finally, just as it pertains to the government and the pipeline issue headed into their fiscal year end, are there more big deals or any very large deals that you’re hoping for or counting on? Or is the guidance you’ve given us and your expectation for that segment based on sort of normal course of business transactions?

Tom Reilly

Much like we’ve seen in prior years, the September month, the second month of our Q2, we do focus on the government business because of the fiscal close. We see a very good volume of business that we’re tracking. Nothing out of the ordinary or nothing super large, though.

Operator

Your next question comes from Israel Hernandez - Barclays Capital.

Israel Hernandez - Barclays Capital

Tom, with respect to the competitive environment, clearly you guys are benefiting from a lot of powerful secular trends. That’s not lost in the marketplace. Are you seeing any changes among your primary competitors, perhaps some other vendors maybe moving into the marketplace to try to get a greater share of the opportunity? I’m just curious as to what you’re seeing from a competitive standpoint?

Tom Reilly

It’s not changing. We’re still consistently, on a percentage basis, seeing the same competitors we’ve talked about in the past. We’re very pleased with our competitive win rate. I do think this is a very difficult category for new entrants, because the amount of domain expertise that has to go into these very sophisticated correlation rules, and it’s a very complex enterprise environment, I think prohibits new entrants from coming in. So we’re very focused on our current competitors in trying to win more than our fair share of business.

Operator

Your next question comes from Erik Suppiger - Signal Hill.

Erik Suppiger - Signal Hill

A couple of questions here, the channel sales, did you say that was 40% or roughly 40% for the quarter?

Stewart Grierson

Roughly, 40%.

Erik Suppiger - Signal Hill

As a percentage of revenue, was that consistent with the prior quarter or past few quarters?

Stewart Grierson

It’s pretty consistent when you go back over the last few quarters, yes.

Erik Suppiger - Signal Hill

You made a change with your senior management and I think there were a couple of other channel management changes. Is there any particular strategies or implementations going in the first quarter, that you implemented in the first quarter for us to be aware of that would have implications throughout the year?

Tom Reilly

So back in July, we did have two folks from our channel organization leave the business. I wasn’t happy to see them go, but what I was happy about was within four weeks are the level of candidates that we were able to talk to and the resources we’ve brought on. I’m very, very positive about the change that’s come about and our new leader Matt Hynes is coming in with some very, I think, interesting perspective and new ideas and new ways for us to even leverage the channel more. So we’re pretty excited about it.

Erik Suppiger - Signal Hill

Then on the appliance side, it was down 41%. I think the prior quarter was 45%; and you said that was the Logger that had come down as a percentage of revenue, or that was what caused most of that downtick. Is that right?

Stewart Grierson

From a mix perspective, Logger generates the majority of our appliance revenue and so, from a mix perspective, it would be that, but you’ll see the potential for this to fluctuate from quarter-to-quarter based on deal dynamics. Yes, Logger is the primary appliance revenue that we’re still selling.

Erik Suppiger - Signal Hill

The Logger has been a good growth driver for you. Was there anything particular this quarter that caused that?

Stewart Grierson

No, I mean, Logger continues to be a good growth driver for us. For example, if you look at Logger year-over-year, Logger has grown more than 50%. So, it continues to be a very good growth driver for us, not only in the use case we talked about with the mid-market sale through the channel, which was a Logger sale, so not only from a standalone mid-market opportunity, but also sold in conjunction with our ESM into the enterprise.

Operator

(Operator Instructions) Your final question comes from Jay Meier - Feltl & Co.

Jay Meier - Feltl & Co.

Stewart, just a couple of quick questions about the movement in some of the operating expenses and the margin going forward; you seem to be pretty stable at the 81% to 82% gross margin. I assume that’s relatively consistent going forward, correct?

Stewart Grierson

Correct.

Jay Meier - Feltl & Co.

You mentioned that you expect the G&A to decline sequentially, but R&D and sales and marketing could increase sequentially and that the tax rate, we should assume around 38%?

Stewart Grierson

That’s right.

Jay Meier - Feltl & Co.

What percentage of that I mean, how much of that increase in R&D and selling and marketing would be in stock-based compensation versus cash?

Stewart Grierson

I’m always talking about this on a pro forma basis. So it does not include changes in stock-based comp. This is more is pro forma expenses that I’m referring to.

Jay Meier - Feltl & Co.

So we should assume that they are cash, then what you’re suggesting?

Stewart Grierson

Right.

Jay Meier - Feltl & Co.

Looking at the top end of the revenue guidance and the top end of the non-GAAP earnings guidance, it would imply a pretty healthy jump in those expenses, right?

Stewart Grierson

Correct.

Jay Meier - Feltl & Co.

So how should we feel about that? How should we think about that out into the second half of the year? Would that be consistent or is that kind of one-time?

Tom Reilly

I think what we’ve talked about is, I’ll go back to actually a year ago, where we basically held hiring flat, particularly in our R&D organization. Obviously, we’re very tight on costs through the whole back half of fiscal 2009, and since the beginning of the fourth quarter of that year, we have been hiring. We’re continuing to hire and provided we see the growth opportunities that we highlighted on today’s call continuing, then we will continue to hire to scale the business and take advantage of those opportunities.

Jay Meier - Feltl & Co.

So I’m assuming there is no change in the man, we should assume that those metrics for those line items would remain relatively consistent going forward, I assume?

Stewart Grierson

Like I said, as long as we have comfort in the continued strength of the pipeline, and continue to deliver the top line, then we will continue to add expenses, yes.

Jay Meier - Feltl & Co.

Tom, I wonder if you can give us a little bit more flavor around what you’re seeing in the federal cybersecurity spend? There’s been a lot of talk out of the Obama administration and others coming out of the cybersecurity review, but we’ve seen Hathaway and a few other top cyber administrators leave their positions. Are you seeing any visibility of budget formulations and plans regarding that? Or how’s the clarity, the environment in the federal space going forward?

Tom Reilly

One thing, we do have Melissa Hathaway as our keynotes speaker at our conference in two weeks. This will be her first public appearance since resigning from the White House, so it will be an interesting discussion. There is no clarity on how the federal spending around cybersecurity is going to come about. I don’t have clarity into that. What I am going to be doing, though, is spending the balance of September and all of October in DC.

I’m relocating there for that full period. I’m meeting with lawmakers, meeting with our partners to get better clarity for ourselves into how that spending is going to occur. So it’s not if it’s going to occur, there’s just questions around how it’s going to be spent and when, but there is a lot of activity in this space. On, I think, to the earlier question around pilots that are occurring, a lot of these pilots are positioning and gearing for future spend. Of course budgets get set for next year, which starts in October.

So we’re just going out to spend time and try to answer that question ourselves.

Operator

This will conclude today’s question-and-answer session. Mr. Reilly, I will turn the conference back over to you for any closing comments.

Tom Reilly

Thank you, Operator. I want to thank everyone on the call for joining us today, and thank you for your excellent and insightful questions. We appreciate the support and we hope you are excited about the opportunities that lie before us, as we are. Again, we look forward to talking with all of you and giving you an update on our progress at our fiscal second quarter earnings conference call. So thanks for joining us, and we look forward to talking with you in the future.

Operator

Ladies and gentlemen, this will conclude today’s conference call. We thank you for your participation.

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