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Blue Coat Systems (NASDAQ:BCSI)

Q1 2012 Earnings Call

August 16, 2011 5:00 pm ET

Executives

Gregory Clark -

Jane Underwood - Senior Director for investor relations

Gordon Brooks - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

David Hanna - Chairman and Chairman of Nominating/Corporate Governance Committee

Analysts

Alex Henderson - Miller Tabak + Co., LLC

Alex Kurtz - Sterne Agee & Leach Inc.

Jess Lubert - Wells Fargo Securities, LLC

Ryan Hutchinson - Lazard Capital Markets LLC

Rajesh Ghai - ThinkEquity LLC

Jack Monti - UBS Investment Bank

Rohit Chopra - Wedbush Securities Inc.

Jason Ader - William Blair & Company L.L.C.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Blue Coat Systems conference call. [Operator Instructions] And as a reminder, today's call is being recorded. Now with that being said, I'll turn the conference now to Ms. Jane Underwood. Please go ahead.

Jane Underwood

Good afternoon, and thank you for joining us to discuss today's announcements, which include the appointment of Greg Clark as Blue Coat's new President and CEO and our financial results for the first quarter of fiscal year 2012. With me on today's call are Dave Hanna, the Chairman of the Board; Carol Mills, our Interim CEO and member of our Board; Gordon Brooks, our Chief Financial Officer; Steve Daheb, our Chief Marketing Officer; and Greg Clark, who is calling in remotely.

Before I turn the call over to Dave, let me remind you that during the course of this call, we will make forward-looking statements about Blue Coat Systems Inc. These include statements regarding expectations concerning market growth and business opportunities including levels of IT spending, expectations regarding future revenues, expenses, margins, profits, tax rates and other financial metrics, plans to develop and offer new products and services and enter new markets, market trends and customer requirements, success of our business strategy, go-to-market execution, and changes in our business model and operations and other matters impacting Blue Coat's financial outlook and future business.

All statements, other than statements of historical facts, are statements that could be deemed forward-looking statements, including any statements of expectation or belief and any statements of assumptions underlying any of the foregoing risks, uncertainties and assumptions include risks that are described from time to time in the reports filed by Blue Coat with the Securities and Exchange Commission, including, but not limited to, the risks described in Blue Coat's annual report on Form 10-K for the year ended April 30, 2011.

No assurances can be given that any of these events anticipated by the forward-looking statements will transpire or occur or if any of them do, what impact they will have on the results of operations or financial conditions of Blue Coat. Blue Coat assumes no obligation and does not intend to update these forward-looking statements except as required by applicable laws.

I'd like to turn the call over to Dave.

David Hanna

Thanks, Jane. Good afternoon, everyone, and thank you for joining us on short notice. I'm delighted to be here with all of you today. The purpose of today's call is to discuss 2 important announcements: a change in leadership at Blue Coat, which I'll cover; and the company's first quarter financial results, which Gordy will cover.

As I'm sure everyone has read in today's news release, Greg Clark is joining Blue Coat September 15 as President, CEO and a member of the board. Mike Borman has departed as President, CEO and a Director. Over the next 4 weeks, Carol Mills, who was been a member of our board since 2009, will serve as interim CEO until Greg's arrival to ensure continuity and drive execution. Greg joins us from Mincom, an enterprise software company where he served as CEO until its acquisition by ABB in late July.

I'd like to take a few minutes to put this announcement in perspective. Last year, the Board made a change in executive leadership to address the challenge of growing our business to the next level. However, as evidenced by our financial results, we clearly have not made sufficient progress in meeting that challenge. The board has determined that a different set of skills is required to drive the dramatic changes we believe are required to put us back on a growth trajectory. We are delighted to report that we have selected a leader with the right combination of technical depth, market insight and operational skills.

Now I'd like to turn the call over to Greg. Welcome aboard, Greg.

Gregory Clark

Thank you very much, Dave. And first of all, let me just say a few words about how excited I am to be joining Blue Coat. I have a – as I'll explain in a minute, I have a very deep background in security systems and security technology and I've been watching Blue Coat right since the '90s. And I'm extremely impressed with the quality of the products, the team and the market share that the company has achieved, and it is really and truly an honor to join the excellent team there. So first of all, I can't wait to wrap up the transitionary duties that I'm finishing at the moment and get over there and I look forward to working with you all through the years to come.

I'll just give you a little bit of my background just to sort of set some of the context. I started my career at AT&T UNIX System Laboratories and worked on primarily the UNIX operating system at that time and up until its acquisition by Novell Corporation. At that time, I started a security software firm in Silicon Valley, the name of the firm was Dascom, which worked on similar technologies to Blue Coat except in the reverse proxy space in Blue Coat securities system. We sold that company to IBM in 1999, and it is the Tivoli access manager, call it the cornerstone of the Tivoli access manager product line. That technology has withstood the test of time, so I am very well versed in both the technical aspects of that as well as all the sales and marketing aspects of that kind of technology.

And while at IBM, I served as Vice President of the security product line at Tivoli and also IBM's distinguished engineer for security products at the time. Following that, I was on the founding team of E2open, which is a cloud-based supply chain application company, that was set up by IBM back in 2001. And that gave me some very relevant experience in cloud-based computing and all the aspects of operational hygiene around how to put together mission-critical cloud-based services. That company services most of the high tech electronic brands that are the bellwethers of the world like Ciscos and IBMs and Dells and what not. And in my tenure there, the cloud-computing model and being able to really deliver cloud-based models reliably was something that we pioneered there. And today, that is still the cornerstone of the electronics industry, so very relevant to the mid-market solutions and the cloud-based solutions coming out from Blue Coat.

Following that, I took over Mincom Corporation back nearly 4 years ago, and as Dave mentioned, just finished the acquisition of that by ABB Corporation (sic) [Group]. And that also gave me a very strong background in enterprise applications, which I think is extremely relevant to the business case around line optimization and what happens there. And also we put together a $50 million recurring revenue cloud-based model in that period as well for delivering those applications into what is the mid-market natural resources sector.

So I think I have some value to bring there from both the technical footprint as well as the various aspects from putting together channels, sales forces and the various pieces of an outstanding business like Blue Coat. So again, I'm very excited about that and also extremely excited to be working with Carol during this 4-week period. As per the announcement, Carol is an extremely well-rounded executive. And we're very fortunate to have that kind of depth on our board with the continuity that the board members bring. And so, really, I'm excited to be joining the team over at Blue Coat. And again, thank you very much to the Board of Blue Coat for giving me the opportunity to do that. So back over to you, Dave.

David Hanna

Okay. Thanks, Greg. It's really great to have you onboard. It's important to point out that until Greg's arrival next month, Blue Coat's senior management team with Carol's leadership will move forward on an urgent basis to implement those actions and make those changes to improve our performance. Carol is a highly talented, seasoned technology executive with strong operational experience and an impressive track record. She has held senior executive positions at a number of technology companies including CEO of Acta, Technology Executive Vice President, General Manager of the infrastructure products group at Juniper and General Manager of the enterprises systems business unit at HP. Not only will Carol be a strong interim CEO, I know she will be a great asset in assisting the transition to Greg's leadership.

Now I'd like to turn the call over to Gordy to review this quarter's financial results. Gordy?

Gordon Brooks

Thank you, Dave. Good afternoon.

Our revenue performance in the first quarter was unacceptable. While we experienced some macroeconomic headwinds in the quarter, largely our own issues and execution have caused our current challenges. We clearly have more work ahead of us to achieve the right balance of product investment and go-to-market alignment between the 2 markets in which we operate. With new leadership and better clarity and execution, we believe we can get this balance right and our performance back on track.

Now turning to our financial results. Net revenue for fiscal Q1 was $110 million, a decrease of 9% sequentially and a decrease of 11% compared with the same year -- the same period a year ago. Product revenue for fiscal Q1 is $59 million, a decrease of 16% from the prior quarter and a decrease of 23% compared to the same quarter a year ago. PacketShaper product revenue was $11 million, Blue Coat WebFilter was $4 million and MACH5 was $5 million. Service revenue was $51 million, this is flat sequentially and increased 9% compared to the same quarter a year ago.

On a geographic basis in Q1, net revenue in the Americas was $48 million and represented 44% of total net revenue. Net revenue at EMEA was $38 million and represented 35% of total revenue, and net revenue in Asia Pacific was $24 million and represented 21% of total revenue. Net revenue in the Americas decreased 11% sequentially and 12% compared to the same quarter a year ago. Net revenue in EMEA decreased 12% sequentially and 10% compared to the same quarter a year ago. Net revenue in Asia Pac was essentially flat sequentially and decreased 8% compared to the same quarter a year ago.

Our U.S. Federal business represented 4% of product revenue or $2 million in Q1 compared with 5% or approximately $4 million in the prior quarter and 9% or approximately $7 million in Q1 of fiscal 2011. During the quarter, we had 3 new deals worldwide whose total deal value was greater than $1 million compared with 6 deals in Q4 and 7 deals in Q1 of fiscal 2011.

Moving on to costs and expenses. Total non-GAAP gross margin decreased 77.7% in Q1 compared with 79.1% in Q4 and 79.7% in the same period a year ago. Product gross margin was 78.8% compared with 79.7% in Q4 and 80.6% in the same period a year ago.

Service gross margin was 76.4% compared with 78.3% in both Q4 and Q1 of fiscal 2011. Our product gross margin was negatively impacted by a shift in product mix to our mid-range products in the quarter, and our service gross margin decrease was driven by the additional costs associated with our cloud-based Web security service coming online.

Non-GAAP operating expenses decreased to $73 million in Q1 compared with $75 million in Q4 and increased from $71 million in the same period a year ago. In Q1, sales and marketing was 42% of net revenue. R&D was 16% of net revenue and G&A was 8% of net revenue. Total employee headcount was 1,331 as of July 31, 2011.

From a bottom line perspective, both non-GAAP operating margin and EPS came in at the low end of our guidance ranges. Non-GAAP operating margin decreased sequentially to 11.1% and non-GAAP net income was $8 million or $0.18 per diluted share. In Q1, the company's profitability was adversely impacted by lower revenue results, along with higher expense structure related to go-to-market investment that we have made over the last several quarters.

Turning to the balance sheet. Cash, cash equivalents and restricted cash balances as of July 31 were $342 million, a decrease of $35 million over the prior quarter. During the quarter, we repurchased 1.9 million shares of common stock for $43 million. Operating cash flow in Q1 was $10 million. Trailing 12-month operating cash flow was $112 million compared with $115 million in the prior trailing 12 months. CapEx was $3 million in the quarter.

Accounts receivable decreased sequentially to $67 million on July 31 from $68 million in April 30 and decreased from $76 million on July 31, 2010. DSO increased to 55 days in Q1 compared to 50 days in Q4 and decreased from 56 days in the prior year quarter. Sequential increase in DSO reflects the expected seasonality of our first quarter.

Total deferred revenue decreased sequentially to $174 million on July 31 from $178 million on April 30, an increase from $160 million on July 31, 2010. Our renewal billings in Q1 were at the highest level ever for our first quarter, clearly demonstrating our strong installed base of customers.

Turning to our outlook for Q2. Our revenue expectations for Q2 primarily reflect the company's current challenges. However, we have also considered uncertainties in U.S. federal spending. Given these uncertainties, we believe it's prudent to take a cautious stance on our expectations for that business, even though Q2 is typically a strong seasonal federal quarter for us.

We currently anticipate net revenue in the range of $103 million to $110 million. Within this range, we expect service revenue, which is primarily amortized from deferred revenue, to be between $51 million and $52 million.

On a GAAP basis, we expect earnings per share to be in a range of a loss of 4% -- $0.04 to a profit of $0.04. In addition, we expect fully diluted share count of approximately 47.5 million shares and annual expected tax rate of 36%.

On a non-GAAP basis, we expect gross margin to be between 76% and 78% and operating margin to be between 6% and 11%. We expect earnings per share to be in the range of $0.09 to $0.17 per fully diluted share, with an expected annual effective tax rate of 30%.

This guidance is based on foreign currency rates effective as of today, and any material change to those rates could impact these projections. Our recent revenue performance has similarly impacted the profitability results against the model we established 2 years ago when we drove to a 20% operating margin at revenue levels around the $120 million range. While our goal is to drive product revenue growth, we also need to be realistic about our profitability model, prudently evaluate our current cost structure and take appropriate actions.

Now I'd like to provide some additional color on Q1 before we open up the call to Q&A. In Web security 2 industry research and advisory firms re-affirmed our leadership position in the market during the quarter. Gartner positioned Blue Coat in its Leaders Quadrant of the Magic Quadrant for Secure Web Gateway. Also Infonetics announced that Blue Coat led the worldwide content security gateway appliance market.

In WAN optimization, we closed the company's largest virtual appliance product transaction in Q1. Loblaws, the largest food retailer in Canada and a Blue Coat security customer, have an issue with visibility and contention for network resources. Loblaw's #1 requirement is to improve the performance of its SAP application. We won the business by being first-to-market with a virtual client operating in conjunction with our unique video and caching capabilities. PacketShaper was also a key factor with its superior visibility and quality of service capability.

In addition, our MACH5 appliance was named the Networking Product of the Year by Techworld Awards. This recognition reflects Blue Coat's more complete approach to WAN optimization in solving the broader set of challenges facing IT departments.

In closing, while we're not off to the start that we wanted to for the fiscal year, we remain encouraged by the opportunities in our market, the depth of our product portfolio and our great customers and partners. We believe we can stabilize our product revenue performance in the short term in order the mid-term to get the revenue growing again. Now let me turn the call back to Jane.

Jane Underwood

Thank you, Gordy. That concludes today's prepared remarks. [Operator Instructions] John, we'd now like to open up the call to analysts' questions.

Question-and-Answer Session

Operator

[Operator Instructions] And first from Ryan Hutchinson with Lazard Capital Markets.

Ryan Hutchinson - Lazard Capital Markets LLC

So clarification and a question, just I'm trying to understand why we didn't have a pre-announcement earlier. That's the clarification. And then on the question, just trying to assess the next step here. I know, Dave, you talked about some actions over the next month, so maybe you could walk us through that. Clearly, it appears the changes you made over the last year have not panned out, so trying to understand the departure of the CEO. And then just, are we looking at a realignment of the cost structure and/or are you seeking strategic alternatives?

Gordon Brooks

This is Gordy. I'll take the first part of that question. Our results on the EPS and the revenue rounded into the range that we provided in our Q4 outlook for Q1, and that is the reason why we did not pre-announce.

David Hanna

Ryan, let me take the second part of your question. I didn't comment in depth on Carol Mills in my prepared remarks, but Carol started yesterday. She is fully empowered by the Board of Directors to take immediate action in a number of areas. And Greg will be, as you heard, coming in, in mid-September, but there are a number of actions from execution, implementation that Carol will be taking, and we can't go into that in depth right now. But I want to assure you that the reason we asked her to serve on this interim basis is we have, as a company and as a board, a very high sense of urgency to continue to make some changes. She'll be working on a regular basis with Greg until he starts. But I think you can look to Blue Coat to make a lot of progress over the next 30 days and certainly after Greg arrives.

Ryan Hutchinson - Lazard Capital Markets LLC

Maybe a bit more direct, I apologize, but I'm just trying to understand the departure of Borman. I mean, is that his decision or yours or both?

David Hanna

Ryan, Mike left the company, and I'm not going to go into more detail than that. But we decided that we needed to make a change in leadership skills, and Mike left the company. And that's -- I'm not really going to comment further on that.

Operator

The next question is from Rohit Chopra with Wedbush Securities.

Rohit Chopra - Wedbush Securities Inc.

Gordy, just a quick clarification on a number. Can you tell me what the Packeteer service revenue was? And question is on competition. I just want to get a sense of how aggressive that has been this past quarter. We've talked about it in the past, but I want to try to get a sense of how that panned out across this quarter.

Gordon Brooks

Sure. Packeteer service revenue was flat at $9 million in Q1 as compared to Q4. From a competition standpoint, on the gateway side of the business, we certainly saw increased competition in the mid-market. We've talked about that in relationship to Websense and to McAfee. As you can see in the discussion about the movement toward some of our mid-range products, we did see some pricing pressure begin to emerge in this quarter that it had -- that we've started to become much more sensitive to than we have in the past. From the WAN optimization standpoint, I think in the types of deals that we were involved in, they certainly were a larger volume of deals that we got to the table more often. In some of those larger deals, we found ourselves in competition with Cisco. Certainly with Riverbed in the mid-range, but certainly much more so with Cisco in some of the higher range larger deals overall. So I think that's probably a pretty fair perspective on the competition in the quarter.

Operator

We will go to Jack Monti with UBS.

Jack Monti - UBS Investment Bank

Just wanted to delve into the gross margin trajectory for the company. It sounds like the shift to mid-range on the product side and the shift to services cloud, shift to cloud on the services side could be more permanent changes. Is that the way you want investors to think about it? Maybe you could just expand on that.

Gordon Brooks

I think in regards to the service revenue, we have fully absorbed the initial rollout of our worldwide data center here in Q1, and so I expect the revenue to start to ratably amortize into the P&L. I expect to recapture some of these service revenue gross margin in the short term. So I believe we're relatively close to the bottom end of the service margin decline. From a product standpoint, the mid-range products, you can really say that the lack of larger deals -- so the movement of only 3 large deals that are primarily our highest-end products, certainly impacted us in the quarter, so we would expect to get back to a better mix. We do have higher discounting that occurs in the mid-range products as we've talked about before, but it's really getting back to a better balance of the higher-range products in the larger deals as well as the volume business.

Jack Monti - UBS Investment Bank

And I guess just to clarify, as you go out and look into your pipeline, do you see more of those larger deals coming back next quarter? Or is that something that's going to take a couple of quarters?

Gordon Brooks

Yes, I'm thinking, again, traditionally Q2 is dominated by larger deals in the federal space. So I think in this quarter, we're being cautious about the potential large deal mix because of the uncertainty in the federal space. But I would expect us to continue to focus on the development of larger deals as they've been -- and a part of the overall trajectory of our revenue stream over the last several quarters.

Operator

Our next question is from Jess Lubert with Wells Fargo Securities.

Jess Lubert - Wells Fargo Securities, LLC

A couple of quick ones. Can you maybe touch a bit upon linearity and close rates in the quarter and when you started to notice that sales were tracking below planned?

Gordon Brooks

Yes. So in our Q1, each of our quarters have a little different linearity. In Q1, we generally see about 50% of our business close by the end of the second month through the end of June. We are relatively close to tracking from a linearity standpoint, maybe a little bit of weakness to our midpoint guidance but not certainly what we saw at the end. So we did see a change of activity in the month of July. Certainly, there are a lot of various aspects that hit a variety of companies lately, but we did see a change of trajectory in July. Like any other company, our July activity is very back-end loaded from a month standpoint. It's not linear within the month, but certainly that transpired as we began to close the last month of the quarter.

Jess Lubert - Wells Fargo Securities, LLC

And Gordy, was that consistent across geographies? And can you perhaps touch upon what you've been hearing from customers early in the October quarter?

Gordon Brooks

I do not have feedback on the latter questions yet. But I think from an overall perspective across the geographies, we saw -- Asia Pac continues to be the most consistent geography from us from a linearity standpoint. I think we really saw that in Europe and the U.S. And the U.S. both in federal -- you can see even with our large Q2, we generally have a stronger Q1 in federal as well as non-federal vertical deals. So I think focus on the U.S. and EMEA saw the biggest impact from the linearity standpoint.

Jess Lubert - Wells Fargo Securities, LLC

And it's right to think that the weakness was more towards the end of July?

Gordon Brooks

Yes, so it's hard to separate from our natural rhythm. And like most companies, most of the business gets pushed towards the end of the quarter and not last month. So I didn't see anything that would have stated that one time in the quarter or one time in the month was more specific than any other.

Jess Lubert - Wells Fargo Securities, LLC

And then my last one, is it your expectation to see sales bottom in the July -- sorry, the October quarter from a sequential perspective, and then improve sequentially during the second half of fiscal 2012?

Gordon Brooks

Obviously, we haven't given guidance beyond the current quarter. But the intent of our remarks around federal is that if you go ahead and look at the impact we think federal may have on the quarter, the guidance provides -- the rest of the quarter to really be -- the rest of the results to be flat in Q1 from a revenue standpoint. So I think our visibility we're only providing through this quarter, so not giving any perspective out beyond it.

Operator

And next, go to Alex Kurtz with Sterne Agee.

Alex Kurtz - Sterne Agee & Leach Inc.

Can you talk about employee retention and channel-partner retention? Obviously, this has been a pretty trying 12 months, maybe a little bit longer depending on when you want to start the process here. Are you doing anything internally to keep top salespeople, top partners still involved with the company? Is there anything you can talk about?

Gordon Brooks

And so, Alex, this is Gordy. A couple of items that we talked about at the, excuse me, in the Q4 conference call about leadership in the Americas and in EMEA from a sales perspective. So Gary and Mark have both been on board now for the entire quarter. And having those leadership positions filled was critical, we believe, to stemming the tide of attrition across those regions. We've seen a significant improvement in the sales attrition that we had really seen spike in the middle and second half of last year. So we believe that trends are positive and we certainly continue on having the right people in place to drive that retention.

Alex Kurtz - Sterne Agee & Leach Inc.

And Gordy, just to follow up on the federal space. Can you just give a little more commentary? Is this an execution problem that you're seeing in the federal space? Or is there some real weakness in budgets that your sales force is encountering out there?

Gordon Brooks

Yes, I think it's a combination of both. We've talked about transition with our federal leadership back in -- with the end of Q4. I believe, we have the right leadership in place from that standpoint. What we did see -- I think we talked about at the end of Q4, a couple of deals even in that period slipping out of the quarter, so where we've been traditionally strong in some of the departmental and agency areas, we have seen that be impacted by budget decision-making and timing.

Operator

Our next question is from Jason Ader with William Blair.

Jason Ader - William Blair & Company L.L.C.

I just wanted to follow up on the fed question. It seems to me that if there is budget that's already been allocated for the fiscal year '11, then it would be spent. And so I'm trying to understand, is it a timing issue where you expect it to still fall within this fiscal year where you have a budgeted project and the agency has the funds already and just hasn't spent them? And if so, why would you be conservative on the October quarter guidance on federal? I'm just trying to understand the dynamics if we're in a budget year where budget's already been set.

Gordon Brooks

Yes, Jason, this is Gordy again. I think a couple of dynamics. One, we certainly work through our resellers in the federal government. We are generally part of larger transactions, not just transactions of uniquely a Blue Coat product. So I think there are a variety of variable or a multitude of variables that impact that timing. When we -- and traditionally in this quarter, we will see those deals firm up even within the quarter, though the budget apparently has been allocated in prior periods, so I wouldn't expect a change to that decision-making. We will gain or lose deals even within the quarter, even though the cycle is relatively -- can be relatively long. So I don't think it's a matter of that we shouldn't have a view of the entire horizon right now and it wouldn't change.

Jason Ader - William Blair & Company L.L.C.

Okay, all right. And then a follow-up -- a somewhat unrelated. When you brought Mike Borman into the company, you talked about the skill set that he had being really ideal for the investments you needed to make especially in the go-to-market side, given Mike's background there. And obviously, it hasn't worked out. But I guess I'm trying to understand when you say that you're looking for a different skill set. What skill set are you looking for?

David Hanna

We think given our current -- the environment, the situation that we're in, we need very strong operational leadership. We need a really deep understanding of our biggest market, the security market. And Greg has excellent execution and operational skills and very strong product background, and so that's a dimension we think is going to be important to us going forward. But he's really a pretty broad-gauge guy, but we were attracted to his operating background and his security knowledge, and we think he has the right skill set, given where we are today and the market with our current situation.

Jason Ader - William Blair & Company L.L.C.

Okay. And when did the Board make this decision roughly, that you were going to go in a different direction? Has this been brewing for a while?

David Hanna

I can't really respond to exactly when we made the decision. The announcement was made, of course, within the last couple of hours, and I'm going to leave it at that. But we are excited about having Greg on board, and I think he's going to have a very big impact on the company and this is a real example of the right skill set at the right time. And as we look at the security market and the WAN op market and what we're doing in the cloud, we think all 3 are excellent opportunities. And we think Greg is going to have a real impact on leveraging these assets and driving us forward. So anyway, that's where we are.

Operator

And next, go to Alex Henderson with Miller Tabak.

Alex Henderson - Miller Tabak + Co., LLC

So I was wondering from an external perspective, we can come up with our estimates of what the revenues might look like and make assumptions about execution and ability to deliver revenues. But we really need a little bit more help from you guys in terms of understanding what you think the trajectory of your OpEx and related expenses are because it's really a discretionary decision that management's going to make and since you've got a pretty rapidly changing management group over there, obviously, it's still a little opaque to people outside of the firm. So do you feel like you need to increase spending over the next 2 or 3 quarters to get in place the assets and capabilities that would provide you the platform for rebounding revenues? Or do you feel like you have the products in place and you can cut back on spending on sales and marketing and cut back on G&A and cut back on R&D and get profitability up in the interim? What's the trajectory of this because we can't guess at it externally at this point?

Gordon Brooks

Well, Alex, this is Gordy. I'll take a stab at that. I think that we have shown over the last several quarters we've made significant go-to-market investments, some of them playing the role of catch-up for investments that hadn't been made previously but I don't think we believe that more resource expenditure is what we need at this point in time. I think probably the work that I'll be doing with Carol over the next month and in conjunction with Greg is to find out how we best focus those resources. I think the comment I made in the script about the balance of resources across our market is critical as far as where we are in each of our product line, what they need from an investment standpoint and to clearly take them to the market in the right segment of the market, is really what we're focused on. Certainly in doing that, we'll be aware of what our cost structure is against our current revenue. I think the goal of the company is not necessarily make a much more profitable smaller company at this point in time, but that's certainly what we will be looking at evaluating is just what the trajectory is, when we think we can go ahead and solidify that revenue base and make sure we're making prudent decisions from a cost structure standpoint.

Alex Henderson - Miller Tabak + Co., LLC

So if we were to look at the OpEx as essentially holding steady to up slightly in the October quarter, is it reasonable to think that that's sort of the same trajectory over the next couple of quarters as you anticipate eventually getting your revenues rebounding that you're going to hold the current line? So we're at a -- the guidance is sort of at the run rate that we should be at. And we can determine, I guess, The Street will have to guess what the trajectory revenues will be, but is it reasonable to think that the costs will be fairly stable at those levels?

Gordon Brooks

I think that's a fair assumption. I think we do have some embedded linearity, we've talked about in the past. Q3 tends to be our smallest quarter from a sales and marketing standpoint, and Q4 tends to be a higher quarter because of the seasonality of commissions and accelerators. But other than those normal seasonal items, I expect the -- currently, as we planned the cost structure to be as you talked about.

Operator

And we'll go to Ryan Hutchinson with Lazard Capital Markets.

Ryan Hutchinson - Lazard Capital Markets LLC

That was basically my question. But I guess, tax rate, Gordy, moving forward, I know it's up. So how do we think about that moving forward as well from a modeling standpoint?

Gordon Brooks

Yes. The tax rate is really driven by the profitability. So the more profitable we were going into last year, the more effective our tax structure is. So I would consider the tax rate right now at back to 30%. That should be able to incorporate any degree of profitability that we have as we show here in Q2. And we'll have to go ahead and grow that revenue to grow the profitability to get back to a much more efficient tax rate.

Ryan Hutchinson - Lazard Capital Markets LLC

And then it was touched on in different ways, but just the MACH5 contribution, it seems to be below contribution or below expectation. I think we were talking about $25 million for the year and then $50 million next, something along those lines. So what's going on there and how do we think about that business? Because that clearly seems to be the catalyst to the growth engine, if you will, or one of the...

Gordon Brooks

Yes, absolutely. And again, back to that balance between the markets, we certainly have higher expectations. Going through the end of Q4, we saw a significant year-over-year growth in that product area. We saw large deals emerge like we talked about with Loblaws but certainly, the true velocity in that market is in the mid- to lower-end volume play. And so our focus is that we're going to get growth out of that product and really have the wood behind the arrow that we need to be playing in those types of deals and not just in only in large deals. So I think that's still -- that's why we called it out. We'll continue to call it out because that's going to be a key indicator of success. I think the other element though is just making sure that we're cognizant of our leadership position from a gateway standpoint, and that we're making the right investments there as well and get these 2 in tandem as opposed to their resources being out of balance from one market to the other.

Operator

And next, we'll go to Rajesh Ghai with ThinkEquity.

Rajesh Ghai - ThinkEquity LLC

My question is for Greg. Greg, I noticed that you've never led an organization which sold appliances through a channel. How are you thinking that helps or hinders you in your role as CEO of Blue Coat?

Gregory Clark

Just a couple of comments on that. I spent 8 years at, E2open which had all kinds of different supply chain models, and so I studied many models such as how Cisco does it or just about everybody that manufactures appliances and ships somewhere -- some form of customer over there. So until I understand that business model very well, I don't see that as an impediment. And very early on in my career, I didn't mention it in the conversation, I worked for a hardware manufacturer, installing technologies that make zero IO cards that were all channel distributed in the mid-market. And that was a company that was relatively successful. They were eventually acquired by Wise [ph]. So I have been around that before, and I am definitely not afraid of that part.

Rajesh Ghai - ThinkEquity LLC

Okay. And Gordy, your OpEx was down sequentially about $2.5 million and down about $2 million on the sales and marketing line. So my question is what drove the decline? Did the company decide to depart from a strategy of investing in sales and marketing quite early in the quarter? Or was that just sales compensation unless it's sales compensation that drove that down?

Gordon Brooks

And that's completely sales compensation for our linearity coming out of Q4, as we have sales compensation accelerators to drive a higher sales and marketing expense traditionally in our fiscal fourth quarter. Those drop off with the re-initiation of the sales plan going into next fiscal year. So sales and marketing expense in absolute dollars generally does sequentially decline between Q4 and Q1. So no change to the other go-to-market investments that we had discussed.

Operator

And that will conclude the Q&A portion. I'll turn it back to the presenters for any closing comments.

Jane Underwood

Thank you. I would like to thank you for joining us today. A replay of today's call will be made available at (800) 475-6701 beginning August 15, 2011 at 5 p.m. Pacific. An audio archive will also be available on our website. We look forward to speaking with you again next quarter. Thank you.

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