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Executives

Tom Reilly - President & Chief Executive Officer

Stewart Grierson - Chief Financial Officer

Rob Dougherty - FD

Analysts

Scott Zeller - Needham & Co.

Keith Weiss - Morgan Stanley

Craig Nankervis - First Analysis

Philip Rueppel - Wells Fargo Securities

Jonathan Ho - William Blair

Jonathan Ruykhaver - ThinkEquity

Robert Breza - RBC Capital Markets

Erik Suppiger - Signal Hill

Jay Meier - Feltl & Co.

Peter Kuper - Lazard Capital Markets

ArcSight Inc. (ARST) F2Q10 Earnings Call December 3, 2009 12:00 PM ET

Operator

Good day and welcome to the ArcSight second 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, Jason. Hello and thanks for joining us today for the ArcSight second quarter of 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 ArcSight’s Quarterly Report on Form 10-Q as filed with the SEC on September 9, 2009 and 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 these figures, please refer to today’s press release regarding our second 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 December 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’ll turn the call over to Tom Reilly, President and CEO of ArcSight.

Tom Reilly

Thank you, Rob. Good afternoon everyone and thank you for joining our second quarter earnings call. I am pleased announced that ArcSight had another strong quarter which we exceed expectation in revenue, net income and earnings per share. Total revenue for the second quarter of fiscal 2010 is $45.5 million a 39% year-over-year increase.

Non-GAAP net income for the quarter was $5.2 million or $0.15 per diluted share. We generated $1.6 million in cash from operations and closed the second quarter with cash, cash equivalents, and marketable securities of $107.2 million.

Our over performance was largely driven by strength in the federal sector, given our second quarter co-insides with U.S. Government fiscal year end. Government accounted for 49% of bookings in the quarter, compared to 36% of bookings for the year ago period.

While we anticipated and guidance for seasonal budget flush, we were fortunate receive a number of excess budget related orders in closing days in September. We are particularly pleased with the contribution from the civilian agencies, which we believe are funded in part by the recently released stimulus dollars.

Many of you’re aware, this past quarter I spent nearly six weeks in Washington D.C., with law makers, customers, prospects, and partners. I’ve been quite a bit in the trip after completing nearly 16 meeting. First and far most, cybersecurity is top of mind for government threshold and they are sophisticated awareness of the seriousness of the threat posed.

There’s also by part of the support and active efforts under ways to improve the security of government operation to protect sensitive information and protect the nation’s critical infrastructure from increasingly sophisticated cyber attacks, often referred to as the advanced persistent treat posed by enemy nation states. With the heighten awareness across both parties, there’s also growing in patients for the White House to appoint an overall cybersecurity coordinator, to align all branches of government under a common strategy and framework.

However, while we wait for employment is we’re showing a significant investment to already being made in many cyber programs are underway are being initiated, but still difficult to pin down just how much in total funds will be allocated cybersecurity in the coming years, when and how will be spend and who will have authority, we can point to many significant investment milestones with past quarter, to indicate that the opportunities real and growing.

In October, the Department of Homeland Security announced, it will hire 1000, cybersecurity professionals over the next three years to lead the agencies initiatives to spend against cyber threats. In October, the National Security Agency announced, plans to build a new $2 billion datacenter camp Williams, Utah to expand upon existing datacenters at Fort Meade and this is part of NSAs signal intelligence program.

The Department of Homeland Security open the national cybersecurity and communications integration center for the purpose of enabling high tech teens of market government network to work more effectively together to respond the cyber attacks. This new operations center combines U.S. Computer Emergency readiness team and the national coordinating center for telecommunications.

This past month, the FBI Deputy Assistant Director of the Cyber Division, justified to the Senate Judiciary Subcommittee on Terrorism and Homeland Security. That the FBI considers the cyber threat against our nation to be one of the greatest concerns of the 21 century.

According to the testimony increasing array of sophisticated state and non-state actors of the capabilities still alter or destroy our sensitive data and in the worse of cases in the mid way from a far the process control systems that are meant to ensure the proper functioning of the portions of our credit infrastructure. Well over the testified that the number of actors to the ability to utilize computers for a legal, powerful and positive devastating purposes continues to run.

In early November, Senate Judiciary Committee approved two bills to address the growing concerns identity theft and data privacy. The first of these is the Personal Data Privacy and Security Act of 2009 and the second is the Data Breach Notification Act. These bills will now require a full vote in Senate for approval.

Finally, the cap off recent news, President Obama did proclaimed October, National CyberSecurity awareness month, in order to promote cybersecurity initiatives to ensure the confidentiality of sense of information, integrity of e-commerce and the resilience of digital infrastructure. It considers our digital infrastructure a strategic national asset and believes protecting it as a National Security Priority. This increasing awareness of the advanced persistent cyber threat based in the nation is translating into budget dollars.

Cybersecurity spending across the government for fiscal 2010 is projected to be approximately $7.5 billion or about 10% of total federal IT budget for $75 million. In fact, inputs of government analyst firms has forecast federal spending on cybersecurity to increase to $11.7 billion in 2014, representing a compound annual growth of 8.8%. This is just apposed against the forecast of only 3.5% increase in general IT spending over the same period.

U.S. Senate, recently passed legislation approving the fiscal 2010 budget for the DHS, within that budget, $400 million has been targeted for improving cybersecurity within the agency. This allotment is approximately 27% greater than the $313 million that was allocated for IT securities in fiscal 2009.

All these federal events, activities and investments this past quarter, the assurances since cybersecurity is being taken seriously by the government and many significant investments are underway. The growing budget dollars reflect the long term opportunity for cybersecurity solution providers. While the federal sector is an important and growing part of our business, the commercial markets continue to represent a significant portion of our business.

For the second quarter, we saw strong performance across all verticals and in most geographic regions. We are particularly pleased with the rebound performance we have seen in EMEA, where product revenue grew by 111% on a year-over-year basis. In our last earnings call, I reported that we’re beginning to see signs of recovery in this region that early positive indicator of improvement was confirmed by this quarters performance, we’re pleased with the regions pipeline looking forward.

We are also pleased with the number of new customers acquired to our channel partners in this region. With data privacy laws increasing requiring companies to capture and store logs for compliance purposes, we’re seeing strong sales of our Logger products, in evidence that the channel can effectively position and sell without any involvement from our direct sales organization.

While these transactions are smaller in size than our typical deals, they also come in a much lower cost. We’re also beginning to see early signs of improving performance in the APAC region resulting from the leadership changes we made early in the year. In total, EMEA and APAC contributed 22.5% of the revenue in the quarter and increase from 18.7% in the prior year.

We added 67 new customers in the quarter, several of which were large competitive displacement, a growing trend that we are pleased to experience. These new customers contributed 38% of total product revenue in the quarter. Financial services telco continue to be our strongest commercial verticals contributing 17% and 7% respectively of second quarter bookings. We saw balance performance across all of the verticals including traditional strong contributors such as utility, retail, healthcare, and technology companies.

I will now summarize our progress against the three business imperative that driver our investments and growth initiative. Our first business imperative is to focus relentlessly on customer success, which results in significant repeat purchases each quarter from our installed base. Existing customers contributed 62% product revenue in the quarter.

Our success in executing against this imperative was reinforced in part by large attendance at our fifth annual User Conference held in September, with over 700 customers and partners. Existing customers that attended this conference subsequently placed add on orders within the quarter, 23 of which we’re for at least $100,000. Six prospects at the conference placed orders within the quarter for more than $5 million combined. We will continue to provide the tools, services, training materials and venues that help our clients succeed.

Our second business imperative is to increase our addressable market by leveraging our core technologies of platforms to enterprise threat and risk monitoring. In October, in our Financial Analyst Investor Day, we spoke at length about the new high value solutions we can deliver for enterprise threat and risk monitoring, including identity monitoring, sensitive data access, data privacy, and ensuring critical transaction integrity, such as broad monitoring usage.

Good example, of our ability to increase opportunity size for an existing customer was a Q2 sales transaction driven by our identity monitoring solutions, whatever customers enlarge U.S. based utility initially deployed ArcSight to address Sox and NERC compliance usage.

This past quarter, they expanded their deployment to include our IdentityView solutions allowing into correlate multiple accounts into a single identity thus enabling them to monitor activity across their IT infrastructure based on user roles and entitlements. This add on purchase was for 48% of the original license amount. We believe enterprise threat and risk monitoring is a next big platform play in enterprise software. We’re well positioned to pursue the significant market opportunity.

Finally, our third business competitive is to expand our market reach by pursuing the mid market in emerging regions through our channel partners. Support of this business imperative, we recently made a significant product announcement with the introduction of ArcSight Logger 4, the fourth generation of our log management platform. This new release enable us high speed structured and unstructured data collection of up to 42 terabytes on a single appliance, it also product ultra fast search and reporting capabilities handling terabytes of data in second via of Google like interface.

Logger 4 also provides unified analysis across all types of data in a single plan of glass for simplified investigation. I’d like other approaches, which either focus fully on structure data for security analysis or unstructured data for IT operation troubleshooting. ArcSight Logger 4 unifies the loading, search and analysis across any type of enterprise installation.

With continued execution on our three business imperatives, we should further extent our market lead over our competitors. In a recent report by IDC ArcSight was the market leader in SIM with 19% of the total market in 2008, which is almost twice that are close this competitor. Given our strong results to-date in calendar 2009, we believe we are continued to gain market share and further our position to as a category leader.

I would now like to take a moment to recognize and congratulate our employees and partners on another great quarter performance. In recent months, our company, customers and team members will recognize with five industry awards. SearchSecurity.com awarded ArcSight the reader’s choice for best SIM products.

Government security news selected ArcSight as the best SIM product in the highly coveted first annual Homeland Security award. Our customer, the FAA was recognized at the same event for having the most effective aviation security program. Shortly, thereafter InfoWorld recognized our customers, the U.S. Army in the top 100 most innovative users of IT to further business goal.

Finally, the award we are most proud of San Jose Business Journal awarded Stewart Grierson, as Silicon Valley’s CFO of the year in the public company category. Considering the caliber and the number of public companies here in the valley, I think there’s a real honor for Stewart. His team and the company receive this recognition.

Before turn the call over to Stewart, I’d like to announce that we will be presenting at a number of investor conferences in the coming month. These include the Barclays Capital Global Tech Conference, Needham Growth Stock Conference and Thomas Weisel Partners Technology & Telecom Investor Conference in December, January and February respectively. These presentations will be webcast and available for viewing on our website at www.arcsight.com.

So now I’d like to turn the call over to Stewart to discuss our financials in greater details. First and foremost, Stewart congratulations on your well deserved recognition.

Stewart Grierson

Thanks, Tom. I think the awards we’ve received are testament to the value our products provide to our customers and how this has driven our strong financial performance of the past 18 plus months including our most recent quarter. As previously mentioned, for second quarter ended October 31, 2009, we had total revenues of $45.5 million, representing year-over-year growth of 39%.

We’ve recorded non-GAAP net income of $5.3 million or $0.15 per diluted share excluding stock based compensation expense of $2.5 million and amortization of intangibles of $0.2 million. This represents 45% year-over-year growth compared to non-GAAP net income in the prior year quarter of $3.6 million or $0.11 per diluted share excluding stock based compensation expense of $1.5 million and amortization of intangibles of $0.2 million.

We recorded GAAP net income of $2.5 million or $0.07 per diluted share versus GAAP net income of $1.8 million or $0.06 per diluted share in the prior year quarter. While our overall revenue growth was 39% on a year-over-year, it’s important to highlight that year-over-year Q2 product growth was 46%. We generated 62% of our product revenue from our existing customers, our installed base continue to be a key driver for our revenue growth with particular strength coming from our existing federal customers in Q2.

As Tom mentioned we had a 67 new customers in the quarter representing 38% of product revenue. We did not have any customers of contributed more than 10% of revenue in the quarter. A number of large deals we close in the quarter can have significant impact on revenue from one quarter to the next.

In Q2 there were nine revenue transactions that were greater than a million dollar inside. This compares to five transactions that were greater than million dollars in the prior quarter. On a non-GAAP basis gross margin for the quarter was 81%, appliances contributed 47% of total product revenue in the quarter.

As in prior quarters appliances revenue continues to be driven primarily by strong Logger sales, although we also remain please with progression of our ArcSight Express product. Non-GAAP operating costs for the quarter were $29.1 million which is a $4.6 million increase in Q1. This increase was primarily driven by increases in sales and marketing cost as well as R&D expenses.

The increase in sales and marketing were primarily to increase variable compensation costs tied to our strong sales in the quarter as well as the cost of our user conference in September. R&D increases were driven by both salary increases from headcount growth and increases in variable compensation. We generated a Q2 non-GAAP operating margin of $7.9 million or 17% of revenue.

We added 27 employees in the second quarter bring total headcount to 460. We are continuing to higher and to accommodate our continued growth we have recently enter into a lease agreement to expand our corporate headquarters by almost 50%. Our effective GAAP tax rate for the quarter increase from the 38% we originally estimated to 47%. This increase was driven by changes in our temporary timing differences, primary related to the significant increase in long term deferred revenue.

This resulted in incremental tax expenses in the quarter of $0.6 million. For modeling purposes we are now using an assumed pro forma tax rate of 31% for fiscal 2010. As previously mention complete information regarding our non-GAAP financial information including reconciliation to the most directly comparable GAAP measures can be found in today’s second quarter fiscal 2010 result press release.

Turning to the balance sheet we enter the first quarter with cash, cash equivalents and marketable securities are $107.2 million and increase of $5.8 million from the prior quarter. We generate $1.6 million in cash from operation and $4.4 million from financing activities driven by proceeds from the exercise of stock option. We used roughly $1 million of capital expenditures.

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 our sales transaction generally to a new partners without establish credits that occur within the quarter, but will only be recognize as revenue in future period when we collect the cash.

As a result in order to understand the change in accounts receivable and deferred revenue from period-to-period, when the safety impact of the net down into consideration. Deferred revenue of $47.6 million at October 31, 2009 was net of $13.9 million of cash basis transaction. This compares the first quarter deferred revenue of $41.8 million which was net of $8.6 million of cash basis transaction.

Accordingly gross deferred revenue increased by approximately $11.1 million from the first quarter to the second quarter of fiscal 2010. On a sequential basis, gross product deferred revenue increased by $4.7 million while gross maintenance and service deferred revenue combined increased by $6.4 million. Accounts receivable was $39.3 million at the end of Q2 compare to $23.1 million at the end of the first quarter.

Once again both these balances are net off $13.9 and $8.6 million respectively for cash basis transaction. Our DSOs for the quarter was 80 days which well above are stated target of 70 days was primarily driven by the large increasing deferred revenue. Our receivables remain largely current and we continue to have very low levels of bad debt.

I will now provide guidance for the third quarter of fiscal 2010. Based on current visibility we expect revenue for the third quarter of fiscal 2010 to be in the range of $43 million to $46 million which represents growth of 18% to 26% over the prior year. We expect non-GAAP net income for the third quarter of fiscal 2010 to be in the range of $4.9 million to $6.1 million or $0.14 to $0.17 per diluted share, excluding stock based compensation expense and amortization of intangible.

Given that strength of our results to the first half of fiscal 2010 and the positive outlook for Q3, we believe that our operating margins for the full fiscal 2010 year will be in the range of 15% to 16% of revenue. We all through remain confidence in our ability to achieve on our stated operating margin target of 18% to 20% by fiscal 2012.

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

Tom Reilly

Thank you, Stewart. Once again we are extremely please with progress were making as evidenced by our performance, strength resolution in our market share advances. These developments combine with an increasingly sophisticated threat environment in our laser light focus on our three strategic imperatives, laser light for continue 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 Scott Zeller - Needham & Co.

Scott Zeller - Needham & Co.

Could you talk to was about visibility going forward refer from other companies who is have reported that the federal space as been particularly strong and there is much more business to be done even beyond the end of the fiscal year for the government and your results for very strong and we saw deferred pickup so can you comment on visibility and the January and even beyond quarters.

Tom Reilly

Yes, Scott this is Tom. Traditionally our Q2 is very strong for federal government was once again, but we noted in past calls and consistent in this call, we are seeing more balance performance and in consistent performance in the government sector for each of the quarters. So, the strength last quarter large part, that where budget dollars available but we also see good consistent performance these quarter and looking forward inline with our expectation.

Scott Zeller - Needham & Co.

So, should we take that demand that we should see steady performance and not at necessarily a big drop off in federal.

Stewart Grierson

I think Q2 obviously you do get the significant impact from the year end budget flush. I think if you just look at last fiscal year; the government was a consistent contributor throughout the year it was still more heavily weight towards Q2. I think that was Tom referencing. You do definitely get a budget flush impact in our Q2.

Operator

Your next question comes from Keith Weiss - Morgan Stanley

Keith Weiss - Morgan Stanley

I wanted to ask you a little bit about if some of those numbers are you given now as far as your outlook for the government stand next year. So when you talking about $7.5 billion in the FY ‘10 budget, can you talk us a little bit about how much of that you guys think it actually addressable by you and how much of that it software? How should we think about those figures in total as far as what it means for your market opportunity?

Tom Reilly

I don’t have the detailed answer to your question. I think that’s something we’d like to find out ourselves. So we’re focused, the reason I want to share those numbers is in magnitude, the percentage of increase we’re seeing year-over-year that the government is putting towards cybersecurity. The portion which is addressable by us, that’s really hard to get to in measure, but what we see is increasing spending in the aggregate going forward and I think that both well for our business.

Keith Weiss - Morgan Stanley

If I could sneak in one more and just in addressing this, I know you spent a lot of time down in DC. In addressing this large and growing federal government cybersecurity opportunity, are you looking to sort of expand your partnerships or maybe look for partners outside of the traditional realm of IT partners maybe more into who traditionally deal with defense initiatives for the government? Is that a part of how this is going to be addressed on a longer term basis?

Tom Reilly

A number of my meetings, while I was in DC, were with the more traditional federal integrators in large number of providers of technology solutions government. They have been very good partners of ours historically. They’re also very good customers of ours historically.

I think we will be investing more in those partnerships in seeing work with them closing, because all of them are making significant investments in improving their skills set, their technology integration skill, consuming our their reference architectures around cybersecurity. So they see it as significant opportunity and so we will continue to closely partner with them.

Operator

Your next question comes from Craig Nankervis - First Analysis.

Craig Nankervis - First Analysis

Tom, I guess from a big picture perspective as we look at the newer opportunities for ArcSight. Are there any newer verticals that are firming up maybe sooner than others that you can see realistically beginning to generate revenue in the current fiscal year maybe over the next two to four quarters such as maybe as power grid, maybe as oversees government or any other newer opportunities for your technology. Any comment there?

Tom Reilly

Yes, I was hoping you wouldn’t feel my thunder. I can point you four areas that we’re looking at, where we think they’re could be drivers of our business. First is around the utilities, and utilities are the concerns there are protecting these data control power grid. You couple of that with the investment being made for this smart grid, which is basically putting to your intelligent endpoints of that in every home and every business.

The opportunity for cyber threats goes up significantly and there was actually highlighted this past month in a 60 minutes special about the owner ability of the power grid to cyber threats. So we are continuing to work with where we have solution around NERC and FERC which is a compliance of best practices, security procedures, working with some of the regulatory groups around utilities and we’re seeing good up tick in utility business.

The next one, they were very excited about, I’m talked in the past is about healthcare. Increasingly, we’re seeing more data privacy build come forward. These data privacy builds where we touch on every industry and every vertical, one of ones that seem to be most serious about its healthcare and really managing who is looking at what patient information allowed the CII about patient data. So we’re investing in our healthcare partnership, in our solutions that area. We think it will be a growing business. Do you think the healthcare, it is both payers and provides. So it’s a very large market.

In there is data privacy law in generational, I mentioned the two builds that went through approvals one of the Committees in the Senate. We are seeing data privacy law like that across the globe. So much of our success in Europe, one of the areas they did very well and Italy, where they recently pass the data privacy law, and these data privacy law is very strong in Europe in part of Asia and increasingly we will see them more data to us.

Then finally, we’re very pleased with our U.S. Government business. We’re increasingly getting excite about the level of activity we’re having with international government looking in their citizen and their classified good information as well.

Craig Nankervis - First Analysis

Impressive number of new customer ads, I wonder if you guys could comment and maybe qualitatively on the complexion of those. Do we assume these are basically mid market ads or are you seeing perhaps more large enterprise or even new government agencies as that are helping drive this larger number?

Stewart Grierson

So I think actually the mix is fairly consistent with the last couple of quarters, where it’s really across that spectrum and so I’ll address it a little bit backwards. We’re definitely pleased with contributions from civilian agencies within the government and some new wins there, but then also Tom talked about success in Italy.

I would certainly say that the channel strategy through our distributors there’s helping with the new customer account, obviously comes at a lower deal size, but we’re fairly excited about for some of the early success and the proof points with the channel, but then at the enterprise level, we continue to add very nice strategic customers as well recorder, so it was very balanced. Obviously significant increase from the prior quarter, but it was fairly broadly based.

Craig Nankervis - First Analysis

While I have you, a couple of quick ones, have your hiring plans changed based on the momentum of the quarter and the current quarter strength that you see?

Stewart Grierson

No, I think they’re on track as we had expected. Obviously, the dynamics of Q2 was the government year end does create a slightly different factor that we consider with that year end budget flush, but no as I said, we’re continuing to hire and add to figure out.

Craig Nankervis - First Analysis

On the deferred, which you addressed were there large deals that might be recognized over multiple quarters or am I to look at this changes only cash basis influenced?

Stewart Grierson

There’s a mix. So even if you look at it on a gross deferred basis, which takes into consideration the cash basis transaction, obviously very nice significant increase and increase in the cash basis transaction, but even on a GAAP basis, on a net basis that went up and there’s some deal that they will ratable over the next 12 months or so. There’s certainly no large deals that sitting on the balance sheet that going to come in discreetly in anyone here.

Craig Nankervis - First Analysis

Then lastly, maybe for you Tom, do you guys plan to sort of indefinitely continue to operate without a formal Board Chairman?

Tom Reilly

We haven’t put a plan in place to put a formal Board Chairman into position. Ernie von Simson has been our Independent Director. We’ve been pretty pleased, how the Board is operating and at the right time I think we’ll consider the Chairman.

Operator

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

Philip Rueppel - Wells Fargo Securities

Couple things, first the business that went through your channel, is that still roughly 40% or was it skewed by the high contribution of federal this quarter?

Stewart Grierson

We actually don’t typically look at federal business as part of our channel program. We view that business very differently although there’s a mix of dealers they go direct to the channel there. I would say, when you look outside of the federal market, the channel’s contributions wasn’t all that different from the prior quarter was north of 40%, but that’s looking at separate from dealers taking the federal business that which is where we typically look at it.

Philip Rueppel - Wells Fargo Securities

You mentioned no 10% revenue customers, if you look at bookings, were there any in ordinary large deals or that are going to be recognized ratably or maybe in backlog based on Q2 deliveries?

Stewart Grierson

Not in ordinately large, no.

Philip Rueppel - Wells Fargo Securities

Finally, can you give us an update on the Cisco partnership on the mobile front and then service part of that. We understand that Cisco is deemphasizing its SIM products. Is that an opportunity for you going forward?

Tom Reilly

Yes, with Cisco announced this past quarter was that their large product will solely focus on collecting log events from Cisco gear and that they will support heterogeneous devices going forward. The Marshalls still be deployed and sold through Cisco. We have always worked to that large product. We did announce a program this quarter where we will extent the use of Mahers capably with our connector technology to heretic environment.

So we do think that does creating an opportunity for us. Those customers that had Cisco large in a shop with multiple device type and then can leverage our connector technology in log appliance as we extent that Marshalls solution. So we’re focused on that as an opportunity.

On the mobile side of things, that we’re getting increasing interest in our capabilities are mobile. One of our messages we take the market is that the perimeters, the traditional securities perimeters evolve and why you have to move, so we call enterprise threat and risk monitoring. For you now monitoring things that are in cloud to monitoring global users, how you have to address social networking tools, which makes your perimeter very poor. So we’re seeing lots of interest in that mobile capabilities just being one part of that.

Operator

Your next question comes from Jonathan Ho - William Blair.

Jonathan Ho - William Blair

Just as a follow up to that question on Cisco, Mars do you see this is an opportunity to pickup some of the customers more as a near term opportunity perhaps into next 12 months as this guys are deciding what they’re doing?

Tom Reilly

Yes, we do Jonathan.

Jonathan Ho - William Blair

Can you talk a little bit perhaps about what’s happening in Asia and some of that channel changes that you guys have put in place there and how that’s sort of translating into results just a little bit of additional color?

Tom Reilly

Yes, so it is the great complex market not only it is based on disclosure here on leases versus you have there already deploy them, but it’s also depended on the partnerships that you less than most business done there through strategically partnership. So, our new leadership in place as been did a very good job as looking to have the right partnerships do in place.

Also building a very strong pipeline and one of our strategies is to focus on our key verticals, where we’ve been successful which is government financial services nation countries so that’s kind of our were we’re pretty pleased that how we’re seeing in team in the ground perform the partnerships we’re putting in place and the development of the pipeline.

Jonathan Ho - William Blair

Can you talk a little bit of about maybe the traction that you’re that your seeing with the ArcSight Express product, I mean obviously the Logger products has been well on the appliance side, but I mean, how should we think about translation into ArcSight Express at this point?

Tom Reilly

Yes, so ArcSight Express is basically are same offering for the mid market, traditionally our ESM products did extremely well at the high end in large enterprise, or else mid market customers saw as maybe over till for them. So, we developed express, specifically targeting in the mid market and we’ve been very pleased, because every express deal that we win, we feel is a deal that we may have lost without having that product in place. So, it’s still a nice GAAP within our portfolio. It’s allowing as to reach into the market and a lot of our new customer accounts that comes from express wins.

Operator

Your next question comes from Jonathan Ruykhaver - ThinkEquity.

Jonathan Ruykhaver - ThinkEquity

Basically, some of the new customers, did you have any sense as to split between software versus appliance?

Stewart Grierson

Of the top of my head, I don’t have percentage with, so most of our new customers though are buying a mix, right. So at the enterprise level, they’re buying both ESM and Logger and/or Connector Appliances, but obviously when you start looking at some of the channel transaction with that of this more so in EMEA, where some of the data privacy laws are creating demand, that’s where we’re seeing some nice standalone Logger deals. Once again smaller in deal size, but that’s going to be breakdown, but I don’t actually the top of my head of the breakdown to ensure appliance only versus software only.

Jonathan Ruykhaver - ThinkEquity

I guess your point, that’s the point I’m trying to get as just color on these sales contribution or just number of customers that are mid market customers?

Stewart Grierson

Yes, I mean so looking at kind of the percentages and we view mid market as customers below $1 billion in revenue that has been sort of certainly, I don’t probably in the 20% to 30% range of our mix and I would say it’s fairly consistent this quarter from a revenue perspective.

Jonathan Ruykhaver - ThinkEquity

You introduced the Logger 4 and you commented on that, but can you just add some color where that product fits with regards to the mid market strategy vis-a-vis, the Express product. Is it more of something that your suffering ESM customers deploy in certain situations around offices, regional offices or is that actually mid market product as well?

Tom Reilly

Three scenarios for Logger, first half there’s Logger only standalone market, where we sell Loggers as standalone product. The features in 4.0 make it even more attractive as a standalone offering, because it has more of breadth and use cases that involve now that we taken unstructured data. Secondly, it is sold in conjunction with Express with ESM, and those scenarios that used as archiving platform.

So it’s always a little difficult to get a very explicit what are each of these cases, but comparably we’ll see Express and ESM sale include Loggers and then we’re expecting to continue to see more standalone Logger sale. So many of the data privacy laws that require you to retain logs for forensics and reporting to requirements all you need is a Logger solution…

Jonathan Ruykhaver - ThinkEquity

Just a final question, looking at the markets you serve. Is there a difference in vendors you see and/or in competitive intensity when you look at software SIM sales distinctly relative to what you’re doing in that market with the appliance is already difference between those two sales from a competitive standpoint?

Tom Reilly

There is, in a large part of where we brought out Express product. So in the mid market, we find those are relation have fewer resources. They may not have half the dozen resources to man at stock would have you might be half of a person time. So you need a solution that fully automated that end users potentially reach a Blackberry letters where as at the high end we have customers with that 24/7 stock, when can you kind of differ offerings for those markets.

Jonathan Ruykhaver - ThinkEquity

Did you feel that you deliver a stronger value proposition and have a stronger competitive position either one of those situations?

Tom Reilly

So traditionally, we have I would say in this strongest player at the high end was though stock, not because our product, well because those environment is very complex and we built a very scalable solutions those very complex environment, but we’ve expressed in longer, we’ve in kind of taking continually best practices we’ve learned at high end and packaging them into appliances home factor and focusing on simplicity of use and bringing the capabilities they traditionally only large organization we had, we’re bringing those to the mid market. So that message is being seems very well.

Operator

Your next question comes from Robert Breza - RBC Capital Markets

Robert Breza - RBC Capital Markets

Just wondering, you mentioned that you’re displacing a lot of cost competitors in competitive situations. I was wondering if you could kind of at least talk qualitatively who is being most and whether that set the high end in kind of SMB market.

Tom Reilly

Our competitive landscape is not changing. When I’ll comeback to the Cisco thing, the Cisco is dropped down the market is really doesn’t change the competitive landscape. We never really viewed Cisco as a competitor as a matter of fact many times of Cisco modules incremental environment. It accelerated the deployment of our solution because really look, have much broader capabilities than they provide it.

So our core competitors remains EMCs RSA division to their envision product, the ManTech and IDM are the core players succeed, where we have done the displacement initially enough in its high end. So we had a number of competitive displacements at the high end, where our competitors in that list haven’t been scale, haven’t been able to address the correlation of these cases that the customer has.

In some cases haven’t help their clients pass audit and so we’re happy to go in there and take that business. I think it comes back to our No.1 business imperative, which we are now getting a reputation of our focus on customer success and that word gets out that we can go to lengths to make sure our customers not only pass their audit, but there’s business secure in this audit very well.

Robert Breza - RBC Capital Markets

Just one follow-up, Stewart, as you look at the DSOs, I was wondering if you kind of take to us about what range we should think about modeling maybe where you think you target range is and maybe just talk a little bit about linearity you saw in the quarter? Thanks.

Stewart Grierson

I still think 60 to 70, Rob, is the right place your modeling. If you look at the last eight quarters and maybe a couple of quarters where we were above that couple below, but what you’ll typically see is when and you seen this before in the fourth quarter where you get a jump in deferred revenue and clearly as a negative impact on DSOs.

So I still think the 60 to 70 ranges right place should be as it’s relate to linearity. Obviously Q2, we’re always favorably impacted by the fact that federal government fiscal year end is in a September, which is in the second month of the quarter that always help linearity in Q2.

Operator

Your next question comes from Erik Suppiger - Signal Hill

Erik Suppiger - Signal Hill

On the federal side you would suggested that you’ll see a seasonal down tick, but you have some pretty good volatility in terms of the federal contribution. Can you give us anymore color as to where you think a normal level might be in other than your Q2 quarters?

Stewart Grierson

It’s a tough question to answer, because over the last let’s say 18 months the level of spend coming from the U.S. federal government in particular obviously has been raising. As Tom talked about a fair amount of length, there continue to make investment, but there’s a certain lag of clarity around when some of this money is going to free up and when some of this program are going to get funded. So it is difficult question to answer.

One thing that certainly hasn’t change in our mind is that the Q2 remain the biggest quarter from the government and so you would typically expect to drop off, but it is very hard to answer kind of what is the normal quarter look like from the federal, because it is a fairly rapidly changing environment.

Erik Suppiger - Signal Hill

In the past your Logger was kind of in the range in terms of contribution of product revenue was probably 25% to 30%. Is it still in that range?

Tom Reilly

It’s still in the higher.

Erik Suppiger - Signal Hill

To 30%, 35% or what kind…?

Stewart Grierson

I’ll say it’s above 30% and so one of the nice things we’ve seen as I mentioned seeing success as standalone deals through the channel, but when we’ve talked about this length before is our ability to go back into our installed base, not only up selling ESM, but what we’re seeing is the earlier customers coming back and adding Loggers to their deployment. So we’re seeing some nice and large size Logger deals into our enterprise account to existing enterprise account and then also typically out of the new ESM deal, it’s fairly rare to see those deals now without Logger being attached as well.

Erik Suppiger - Signal Hill

That was more than 30% in your appliances, I think you said 41%, is that suggest the Expresses probably less than 10% of revenue at this point?

Stewart Grierson

Appliance was 47% and I would say that’s probably a pretty fair, I guess.

Erik Suppiger - Signal Hill

Appliance was 47%, you said?

Stewart Grierson

Right, yes.

Erik Suppiger - Signal Hill

Lastly, what did you say the international contribution was?

Stewart Grierson

In a 0.5%, I think an half a year ago.

Operator

Your next question comes from Jay Meier - Feltl & Co.

Jay Meier - Feltl & Co.

You mentioned that you got some September and orders out of the federal vertical. Can you quantify what those last minute orders looked like?

Tom Reilly

We don’t actually provide kind of what the dollar magnitude of what those orders were. I mean obviously, we talked about the fact that federal was 49% of bookings for the quarter, which is obviously much higher than it is typically and a lot of that business come in September, somewhere deals that clearly we are tracking and expected to come in and then there was other part of it, where it was nice upside.

Jay Meier - Feltl & Co.

As far as your international opportunities, I don’t recall if I have ever asked this before, but are you restricted at all by National Security Export restrictions?

Tom Reilly

As it relates to the encryption technology in the product, so it’s the same restrictions that any other vendor who has SSL in their product would be affected by.

Jay Meier - Feltl & Co.

Regarding you encryption and related to the federal government’s interest in identity management going forward and many of those bills that you mentioned. Are you in compliance with FIPs tool one right now do you know?

Stewart Grierson

I know that’s tool one, but the recent Logger that we released in that steps compliance.

Jay Meier - Feltl & Co.

Steps 140?

Stewart Grierson

I’m not sure, which FIP, which version it is, Jay? You did mention identity monitoring in the federal government. We believe identity product is a tremendous offering for the federal market.

Operator

Your final question comes from Peter Kuper - Lazard Capital Markets.

Peter Kuper - Lazard Capital Markets

Actually, touching on something you brought up, Tom. You mentioned a lot of the federal government money particular, along those lines, anything you can see out there that might be more of a near nature versus, I think you mentioned smart grid, which we think kind of a little bit slower to getting the money rolling that given issues over standards what have and then kind of a model of question, I guess think that get in the last minute.

Given the guidance and looking at the maintenance stream, etc. less services kind of really gets clobbered here sequentially licenses need to make up the shortfall. Give us a little color Stewart on that just a function of the government up tick and we’re just normalizing here or a little more thoughts on how you built up the guidance there, please?

Rob Dougherty

Federal in my investigation when I was back in DC on two parts which is, how is the federal government going to drive spending in the private sector. Healthcare, utility, power grid, transportation system, finance, and services that’s all owned by private sector, I couldn’t pin it down, we don’t experience with our federal government would drive that, it seems as though we can expect a more regulation coming out, I can’t expect more teeth in these regulations.

So for instance, our HIPAA has traditionally been focused on healthcare, about most recently the High Tech Act that President Obama has talked about, now has more teeth in it if you have data privacy issue with the healthcare. So what we will see is, I think more data privacies mandates coming out, more teeth around protecting the power grid and these will out in the forms of compliance with the expenditure.

The federal government is, how much money federal government going to spend on protecting its operation and those with the figures I actually referred to you in the comment all those budgets were going to the DHS cybersecurity initiatives protecting their operations whether it’s border patrols or what you have. Likewise, the large number I shared on the federal government.

Tom Reilly

Sure, is still on the guidance piece of it Peter, I think fairly, if you just look at the dynamics of the quarter where product revenue will be 46% year-over-year was fairly not looking at our guidance forecasting we’re going to see that same kind of contribution in the federal government on the product side. Yes, you’d expect maintenance and services continue to increase, but we’re fairly not forecasting. We’re going to get that kind of contribution in Q.

Peter Kuper - Lazard Capital Markets

Really as just the government upside nothing more to read into than that?

Tom Reilly

Right. Alright, so thank you operator and I want to thank everyone on the call for joining us today. As always we appreciate your support and we hope you’re as excited about the opportunities that lie before as we are. We look forward to updating you on our progress and our fiscal third quarter earnings conference call. Thank you everyone for joining us.

Operator

This does conclude today’s conference. Thank you for your participation.

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