Secure Computing Corp. Q3 2007 Earnings Call Transcript

Secure Computing Corp. (SCUR)

Q3 2007 Earnings Call

October 29, 2007 4:30 pm ET

Executives

Jane Underwood - Senior Director for investor relations

John McNulty - Chairman and Chief Executive Officer

Dan Ryan - President and Chief Operating Officer

Tim Steinkopf - Senior Vice President of Operations and Chief Financial Officer.

Analysts

Rob Owens - Pacific Crest Securities

Jonathan Ruykhaver - ThinkEquity Partners

Eric Martinuzzi - Craig-Hallum

Sarah Friar - Goldman Sachs

Josh Jabs - Roth Capital

Fred Ziegel - Soleil Securities

Erik Suppiger - Signal Hill

Joe Maxa - Dougherty & Company

Michael - Friedman, Billings

Brian Thackery - Deutsche Bank

Jordan - Jefferies & Company

Presentation

Operator

Welcome to Secure Computing Corporation's Third Quarter 2007 Results Conference Call. All participants will be able to listen-only until the question-and-answer session, which will follow today's presentation (Operator Instructions).

Today's conference is being recorded. If there are any objections, please disconnect at this time.

I will now turn the call over to Ms. Jane Underwood, Senior Director for investor relations. Ma'am, you may begin.

Jane Underwood

Thank you and good afternoon. Welcome to our third quarter 2007 results conference call. On the call with me today is John McNulty, our Chairman and Chief Executive Officer, Dan Ryan, our President and Chief Operating Officer, and Tim Steinkopf, our Senior Vice President of operations and Chief Financial Officer.

Before I turn the call over to Tim I'm going to make a cautionary statement regarding forward-looking statements.

During the course of this call and the question-and-answer session following management's remarks we will make forward-looking statements with the meaning of section 27A of the Securities Act of 1933 as amended and section 21E of the Securities Exchange Act of 1934 as amended. Such forward-looking statements are subject to the Safe Harbor created by those sections.

These statements include, for example, statements, which may infer future results such as anticipated future operating results, metrics and statements that our products will be successful and will be available as planned.

Our actual results could differ materially from the forward-looking statements. Factors which could cause actual results to differ include, for example, rates related to competition in the security industry, changes in customer requirements, delays in product development, and the other factors and risks identified in our press release and in the documents that we filed with the SEC.

We do not undertake any obligation to correct or update any forward-looking statements that may become inaccurate.

Now I'd like to turn our call over to Tim.

Tim Steinkopf

Good afternoon, everyone, and thank you for joining us. My comments for today's call will focus on what we view as the key financial takeaways for the third quarter along with our Q4 guidance. Q3 billings, non-GAAP revenue and earnings per share all either met or exceeded the guidance ranges that we previously provided for the quarter.

We also generated record cash flow from operations, which allowed us to pay down our debt by another $10 million, while also paying $1.4 million of interest expense. I'd like to point out that we have reduced the debt by $32 million since the beginning of this year, which is well ahead of plan.

In Q3 billings were $74 million and non-GAAP revenue was $65.2 million. Consistent with our guidance Q3 billings for our gateway security products were approximately 89% of our total billings and billings for our identity and access products were approximately 11% of our total billings.

Domestic billings, excluding the U.S. federal government, were 48% of total billings and international billings were 30%. In the quarter we closed six seven figure deals and an additional 127 deals over $100,000, which is a record for the Company.

Deferred revenue increased by $11 million or 8% sequentially, bringing the total deferred revenue balance to approximately $154 million at the end of September. Continuing our trend of operating margin improvement, non-GAAP operating income for the quarter was 13% of revenue, up 1% sequentially.

Non-GAAP net income for the quarter was $6.4 million or $0.09 per fully diluted share. In Q3 we generated a record $12.8 million in cash from operations. In the first nine months of this year we have generated $0.51 per share in cash from operations.

The Company's cash and cash equivalent balance was $10.7 million on September 30th. Currently we have an outstanding balance of $56 million on the term debt.

Now, I would like to turn to our outlook guidance, which is based on current expectations. The following statements are forward-looking and actual results could differ materially. For the fourth quarter of 2007 we expect billings to be in the range of $76 million to $79 million.

Non-GAAP revenue is expected to be in the range of $67 million to $69 million. Non-GAAP gross margin is anticipated to be approximately 76% of non-GAAP revenue. Non-GAAP operating expenses are expected to be in the range of $42 million to $43 million.

Fully diluted weighted average share count is expected to be approximately 76 million shares. Non-GAAP tax expense, which also approximates our actual cash outlay for taxes, is expected to be approximately $800,000.

Interest and other expense is expected to be approximately $1.4 million, And our Q4 non-GAAP earnings per share is expected to be approximately $0,09 to $0,11 per fully diluted share.

Turning to the billings breakdown of our product lines in Q4, we expect approximately 88% for Enterprise Gateway Security and approximately 12% for identity and access products. In Q4 we expect to generate cash of approximately $12 million to $13 million from operations.

We expect our federal government billings for Q4 to account for between 15% and 18% of total billings. And before I turn the call over to John I would like to mention that Secure Computing will be hosting an investor day on Thursday, December 6th in San Francisco for sell-side analysts and institutional investors.

We will also be webcasting the event for those people unable to attend. If anyone should have any questions regarding the investor day please contact Jane.

At this time I'll turn the call over to John.

John McNulty

Thank you, Tim and good afternoon, ladies and gentlemen. In Q3 our team's ability to execute, coupled with our industry-leading products, resulted in another quarter of solid financial results. Performance was driven by strong demand for our enterprise gateway appliances as well as solid growth in our IAM business.

Our U.S. federal team produced another solid quarter, as they generated 22% of our Q3 billings, consistent with guidance. As predicted, today's security landscape is now dominated by blended threat attacks using multiple protocols and applications.

The proliferation of live content from the Web 2.0 world is creating an expanding environment for malicious activity. Yet, most corporate users are not prepared for this wave of threats. Last quarter we conducted a joint research study with Forrester Research on enterprise security and found that 79% of security respondents had experienced recent malware attacks inside their network.

The explosive growth and insidious nature of malware attacks, coupled with the rapid adoption of Web 2.0 technologies and an increasingly demanding regulatory compliance environment, have bolstered the demand for our comprehensive product portfolio and is also providing growing momentum of opportunities in our pipeline. In Q3 a few examples of customer successes driven by security and compliance mandates included.

First, the Orange County Healthcare Agency purchased Sidewinder for application layer security to help achieve HIPPA compliance and Webwasher to solve malware threat issues. In this upgrade we displaced two major competitors that could not meet the customer's requirements.

Second, the leading global medical technology company and an IronMail customer purchased SafeWord to improve its IT compliance capabilities. I'd like to point out that we won this new business in a highly competitive bake-off against two of our major competitors.

Third, a large statewide network of schools and a SmartFilter customer purchased Webwasher to update its caching system, as well as become compliant with the Children's Internet Protection Act.

Now I'd like to turn to some product highlights. As expected, we saw rapid acceptance of our newest network gateway product Sidewinder 7.0, as adoption was more than 3X over the prior quarter. It's important to note that we are still early in the upgrade cycle, as Q3 was only the second full quarter of the product's availability.

Also in Q3 we introduced Webwasher 6.6, which is the only Enterprise Gateway Security solution that integrates caching and security onto a single appliance. Importantly, the response to Webwasher 6.6 has been very strong as this product addresses the highest growth market in IT security.

According to Gartner, malware filtering in the Web Gateway will increase from 10% to 15% penetration in enterprise networks in 2006 to 70% by 2011. Webwasher provides several superior security features over our competitors' products, including the ability to stop malware attacks hidden in websites, even when no signature exists.

We believe WebSense, SurfControl and Blue Coat only solve part of the problem and do not offer the breadth of security that we provide. Not only are we well positioned in the early stage of this growing market, but we are also seeing a growing number of Net Cash customers choosing Webwasher over the competition and we believe great opportunities exist with dissatisfied surf control customers.

From a performance standpoint Webwasher is highly differentiated from the competition. Recently an independent test against 874,822 unique malware samples conducted by AV Test Labs found Webwasher's anti-malware engine achieving 99.86% detection success, surpassing all leading vendors' security products.

Demand for our messaging gateway products continues to be strong, as e-mail remains a leading threat vector. One customer success story that I'd like to highlight is the Health Alliance of Greater Cincinnati.

This organization was experiencing denial server attacks and spam issues that were resulting in bandwidth overload. Their spam problem was so significant that each employee was receiving over 700 spam messages per week. Following the installation of IronMail spam mails have been dramatically reduced to only one or two per week per employee.

In closing I'm pleased with what we have accomplished so far this year and believe we are well positioned for a successful Q4 and beyond. Before I turn the call over to Dan I want to mention that I am delighted to have him join our company.

Dan has been on board with us for eight weeks and has already become an integral part of our senior management team. He brings valuable expertise and exceptional energy and insight into the company. It's great to have you, Dan.

Dan Ryan

Thank you, John. It's been an exciting first 60 days here at Secure and I'm even more optimistic about this company and the opportunity than when I joined. Secure Computing has the richest product portfolio in the IT security market, one that comprehensively addresses the evolving threat environment, including malware, spam, application protection, data leakage and identity theft.

We believe that no competitor can match the depth and breadth of our solutions. John spoke about Web 2.0 threats. This quarter we launched secure Web 2.0 Anti-Threat, or SWAT initiative. The SWAT initiative brings together news and timely information, technologies, best practices, and, of course, products to help protect an organization's assets in the Web 2.0 world.

Another great opportunity for Secure is the increasing requirement for application layer security. According to an article in Federal Computer Week, application layer attacks are outpacing attacks on networks by three to one. Today Sidewinder is the leading enterprise application layer firewall available on the market and it still maintains a flawless record of zero compromises and emergency security serve advisories.

One specific driver for our firewall business is the payment card industries revised data security standard. Among the requirements is the deployment of an application layer firewall in front of all web-facing applications by June 30, 2008.

While the company has posted five consecutive quarters of solid performance, we believe we can do much better and we are committed to doing so. We're well underway in our search for a new senior vice president of worldwide sales. In the meantime John, Tim and I are working very closely with our sales teams to ensure that we deliver a strong Q4.

Operator, we would now like to open up the call to questions from sell-side analysts.

Question-and-Answer Session

Operator

(Operator Instructions) Rob Owens from Pacific Crest Securities, you may ask your question.

Rob Owens - Pacific Crest Securities

Yes. Good afternoon, everyone.

John McNulty

Hi, Rob.

Rob Owens - Pacific Crest Securities

Wanted to drill down on the guidance a little bit. I guess, at the midpoint of the revenue range you're looking for about a 5% sequential increase, somewhat below what you've seen historically, and listening to some of the successes you've had with the big deals and the new product cycles just curious, is this something you see out there or just conservatism on your part?

Tim Steinkopf

Hey, Rob, it's Tim. We do try to provide guidance that's, as we would term, appropriate, very proper. I guess in some respects at this point in the quarter you're always leaning to be a little bit more conservative, so if you wanted to, a one word answer is probably yes, we're being conservative. It is not indicate of any type of trend or something we're seeing in the market. It's just -- you know, it's the end of October, we're guiding for Q4 and we'll probably being a little bit conservative.

Rob Owens - Pacific Crest Securities

Okay. And number two with the new guidelines around PCI and the timing of the regulation, do you expect a pretty large cycle there? And with the new Sidewinder product out how much could that mean to your growth in revenue? Thanks.

John McNulty

Go ahead.

Dan Ryan

It's Dan, hi. I think, without commenting on the amount of revenue growth I think if you look at the opportunity for the company application firewalls represent a large one. This represents one sector of application firewalls.

So I think tactically it could be a great opportunity for Secure. I think beyond this, though, the reason that they're using application firewalls is because of the critical nature of the applications and the data. That same logic should apply beyond just the payment card industry, as well, long term.

Rob Owens - Pacific Crest Securities

True, but do you get a sense relative to the PCI regs that you're already into this cycle or this cycle should begin in the next few quarters?

Dan Ryan

Yeah, I think we've seen some activity currently with our customers, our financial customers, and I would imagine it's just on the beginning, the front end of that.

Rob Owens - Pacific Crest Securities

Great. Thanks.

Dan Ryan

Thanks, Rob.

Operator

Jonathan Ruykhaver from ThinkEquity Partners, you may ask your question.

Jonathan Ruykhaver - ThinkEquity Partners

Hi, guys.

John McNulty

Hi, Jonathan.

Jonathan Ruykhaver - ThinkEquity Partners

Can you comment on what the bookings mix led to the lower revenue realization rate and should we expect a portion of deferred deals going forward?

John McNulty

All right. Jonathan, you broke up there for just a second right in the middle of your question. Could you repeat it?

Jonathan Ruykhaver - ThinkEquity Partners

Yes, I apologize. AT&T coverage is worse despite what they're saying. Just try to get a sense to what products in the bookings mix were deferred. It went to lower revenue realization rate.

Dan Ryan

Well, as you know, we ship products. We also book and bill support renewals and subscriptions. Those are really the three major areas. We did have an increase, or a little bit of an increase in the mix of subscriptions versus product and support and so over time that will definitely roll back into revenue.

Jonathan Ruykhaver - ThinkEquity Partners

Okay. So should we focus more on the bookings number and bookings guidance as an indication to the growth for the company?

John McNulty

Obviously, Jonathan, the billings are key. That's going to equate either to revenue or deferred, but also the cash generation, I think, is a great indicator of the health of the company.

Jonathan Ruykhaver - ThinkEquity Partners

I guess just one final question. Of the six seven figure deals can you comment on what products drove those deals?

Dan Ryan

They were across all product lines and just to add onto John's comment for one second, historically we've been tracked on revenue and in the change in deferreds. Now obviously people are tracking billings as well. In some respects those are interchangeable. I think going forward people definitely probably will be tracking us on revenue and the change in deferreds, because that's an overall indicator.

Jonathan Ruykhaver - ThinkEquity Partners

Right. Okay, thanks, guys.

John McNulty

Thank you.

Operator

Eric Martinuzzi from Craig-Hallum, you may ask your question.

Eric Martinuzzi - Craig-Hallum

Thanks. Curious just from a year-over-year perspective, here at the mid-point of guidance we're talking about around 8% growth on the non-GAAP rev December '07 to December '06. Given the product portfolio that you guys have and you talked about it in the prepared remarks, it's robust.

You cover the breadth of the enterprise needs for large enterprises. What are you going to do, and I'm looking for strategic commentary, perhaps from Dan as far as sales and marketing? How do we get this thing to double-digit growth, a solid double-digit grower day in, day out, quarter in, quarter out?

Tim Steinkopf

Hey, Eric, it's Tim. I'm going to turn over to Dan in a second, but one thing to note on the year-over-year growth is Q4 of '06 was in some respects a blow-up quarter, really a great quarter. The sequential growth from Q3 to Q4 of '07, even though today we're just providing guidance, our goal is to really provide great results in Q4 of '07 that would stack up excellent as far as the sequential measurement.

But, Dan, if you want to talk more about strategically in sales and marketing?

Dan Ryan

Yeah, I think -- first of all, I think there's nothing broken as it is today. I think what we're looking at is making improvements to improve the growth rates. I think that identifying the key initiatives that we want to go after and identifying the markets where we can be number one or two and focusing on those is really one of the things that we'll be doing going forward.

And if you look across our portfolio, we have a legitimate shot to be a number one player in Web Gateway. We're certainly in the top two in messaging, and I think in firewalls generally we're not in the top two, but I think if we focus in on a segment of the firewall business where we can be number one, we can grow that, because that to substantial growth as well.

So I think all the way across these we have an opportunity to be in the top couple players and that's where we have to put our energy and money and organize our sales. It's not just sales and marketing. It goes all the way back into the product management and product development teams as well.

But I think that we have a great starting point and I'm really excited to just try and help move it along to the next level.

Eric Martinuzzi - Craig-Hallum

But as far as the distribution specifically, is there going to be a preference for emphasizing one over the other, direct versus indirect, or are you going to be pushing both?

Dan Ryan

Yes, we're focused primarily on the indirect channel, so one of the things that we need to do or plan to do is continue to improve our leverage there. That again goes not just to sales and marketing but all the way back into the products and our commitment is to the indirect model and I think that's what we're going to try to leverage going forward and that will improve our productivity.

John McNulty

Just a quick comment, Eric. The direction portion of our revenue is accounts that we have sold to on a direct basis for many years. It's the legacy, it's an artifact and we continue to try and push them into channel.

Eric Martinuzzi - Craig-Hallum

Thank you.

Operator

Sarah Friar from Goldman Sachs, you may ask your question.

Sarah Friar - Goldman Sachs

Good afternoon, everyone. Tim and company, you're doing a great job on the margin front and that's clearly showing up on the cash from operations. Tim, where do you think you can get to over the next 12 months, given that you are trying to balance a company that is trying to really grow the top line and get leverage that way.

But obviously there's some low-hanging fruit from the acquisitions you've made and getting rid of some of the cost overlap and so on?

Tim Steinkopf

You hit on the key item there and that's balancing between the two because if you choke off expenses or really control the expenses too tightly, you can choke off the growth. So what we're trying to do is exactly as you kind of asked is trying to balance that.

And some of the expansion that you've seen in the last one, two, three, quarters has been the ability to, as you pointed out, leverage or cut out some of those overlapping or duplicative costs. As we go forward, our target model, I won't say in 12 months.

But our target model is to drive back up to say 18% to 20% or 20% operating margin. What we are presently working on for '08 is judicious investment in sales and marketing, product development that will drive greater than market growth rates.

We're not prepared today to actually guide to what does that mean for the exiting Q4 of '08 operating margin, but you rest assured we've got a keen eye on exactly that mix and balancing between investing, driving up the leverage in productivity on the sales and marketing R&D, G&A lines but then in delivering that down on the operating line.

Sarah Friar - Goldman Sachs

But we'd definitely not cap that at 13.5% margin? That should be able to go higher.

Tim Steinkopf

Definitely not, and again, our target is 20%. So, not sure if we're going to guide to that within 12 months or maybe a little beyond 12 months, but we; our focus is on how do we go from 13% to 20% appropriately, while also investing appropriately in the revenue growth.

Sarah Friar - Goldman Sachs

Got it. And then just one follow-up, John and Dan. On a market perspective side I see one of your competitors, Vasco, on kind of the IM side did not have a strong quarter and there was a lot of talk about the shift in tokens from hardware into true software tokens.

Could you comment on that. Is that really a trend that you're seeing, because we haven't heard that so much as we've talked to customers?

John McNulty

Sarah, it's John. I think we see more of that in the software than in Europe and I'm sorry, more of the software vent in the U.S. and more of a token vent internationally. So I'm not sure that anybody's got the answer yet to the whole thing and there's like 57 flavors out there and everybody wants their own.

Sarah Friar - Goldman Sachs

Got it, but you don't see a major dislocation happening right now, do you, or has there been a real shift?

John McNulty

Sarah, I think back eight years ago I walked into the Company and there was an article on the poster board in our with the development team and on safe board and it said, tokens were dead and it was dated 1995 and tokens are still very much alive, hard tokens.

So, and I think they will be for some time to come because they've got some great advantages. Certainly software tokens are; and we have a number of different approaches to a software-based solution, so we're going to see a mix for a long time to come.

Sarah Friar - Goldman Sachs

Great. Okay. Thanks a lot.

Operator

Josh Jabs from Roth Capital, you may ask your question.

Josh Jabs - Roth Capital

Hi, good afternoon. I just want to go back again to the year-over-year growth rate projection for Q4. You talked about some of the trends that you're seeing, both on the malware side and just as far as industry adoption of products and customers looking for a broader sweep at the gateway.

But if we look at that 8% year-over-year growth number, is there any reason that that shouldn't accelerate as we look at 2008? I know there's been some confusion here over sequential growth rates given the acquisitions, but we're starting to get a little bit clearer number for year-over-year growth rates. Is there any reason that that shouldn't accelerate into the double digits?

Tim Steinkopf

Hey, Josh, it's Tim. So, we're not providing guidance for '08 today, but having said that, we will not be guiding; we will be guiding for '08 above 8% growth rate. So to answer your question, I'm not sure if it's a yes or a no, but in '08 we expect to grow greater than what we're guiding to presently for Q4.

Josh Jabs - Roth Capital

Okay. And then looking at the margins here there was a little bit of a jump in G&A. Anything unusual going on in that line?

Tim Steinkopf

No nothing, unusual. I have to double-check what you're looking at, but nothing unusual in G&A. We're about; we've been running at least on a non-GAAP basis; non-GAAP revenue to G& A it's about 5%, which is at least a couple points below the lowest benchmarks that we've been able to see, so we actually did a pretty good job efficiency on that line. So if it bubbled up a little bit, nothing in particular there.

Josh Jabs - Roth Capital

Okay. And I know you're not breaking out the products by segment here anymore, but can you give us a little more color on what you're seeing in your gateway products as far as adoption rates between specifically between messaging and the firewall revenue?

John McNulty

Probably the place to start, I think, is what we're seeing that we're most happy with is the cross selling that we're able to achieve inside our customer base. Customers that are using one product are buying a second and a third product from us, which is really, I think, indicative of the synergistic effect of the full suite at the gateway.

The products have blended and continue to blend into each other very nicely where you've got modules running on all three that improve the effectiveness of whichever one you're using of the gateway appliances.

So, we believe the opportunity exists for very healthy growth in all three segments, led probably by Web Gateway because of the penetration aspect. In the prepared remarks we talked about Web Gateway being at 10% to 15% according to IDC in 2006 and that absolutely positively has to increase dramatically over the next few years.

I think they're being very conservative, which usually doesn't happen with the market prognosticators, in saying that it would increase to 70% by 2011 because the blended attacks are largely becoming successful via web-based malware.

Josh Jabs - Roth Capital

Okay. And then I guess finally here, any update on the OEM, on the OEM front and what you're doing with TrustedSource?

John McNulty

OEM represented 6% of our revenue in Q3. The TrustedSource product -- the first product the company that we rolled out with was F5. It's getting traction, albeit not as quickly as we would have projected on either our side or the F5 side, but we put together some joint promotions that we're hopeful will kick it up a bit.

Josh Jabs - Roth Capital

And then, I guess, last question here for Dan. Dan, you came from a large industry player and how do you see the portfolio and the positioning of Secure, given some of the acquisitions that we've seen, specifically on the web application side by some of the larger application vendors?

Dan Ryan

If I understood the question correctly, I think the position of Secure has really -- if you look at our product suite, we call it Enterprise Gateway Security, you could also think of it as application level firewalls across the board or Internet firewalls.

I might think there's a great opportunity in the -- in partnering or putting our application firewalls in front of both custom developed and productized applications by the vendors you're referring to.

These are web applications that are really running commerce today and I think that represents a substantial opportunity for Secure. When I look at where I came from in the enterprise software space and looking at what Secure has to offer that space, I think it's meaningful or I think it's actually really the wave of the future.

Josh Jabs - Roth Capital

Okay. Great. Thank you.

Operator

Fred Ziegel from Soleil Securities, you may ask your question.

Fred Ziegel - Soleil Securities

Hi, guys.

John McNulty

Hi, Fred.

Fred Ziegel - Soleil Securities

There have been some interesting articles of late talking about for lack of a better term, mobile firewalls going into the government, I guess, more specifically a partnership between you and General Dynamics.

Can you talk and size that? I know funding obviously will be an issue, but what's the opportunity there?

John McNulty

Good question, Fred. And I think the opportunity is from -- it's very hard to put our arms around because there's great potential, I mean absolutely outstanding potential if -- the articles that were -- made their way into the press were based on a press release that we did with General Dynamics and the potential is basically for military battlefield management with a ruggedized firewall connecting the network where you're literally running your battlefield and tying back into headquarters units and the like.

So you think about that and everything that moves on the battlefield potentially could have one of these things involved. That's big numbers. But like most government contracts, it was contracted and developed in cooperation with General Dynamics, but there is no definitive quantity that has been committed to at this point, so I guess we won't count the chickens before they hatch.

Hopefully knock on wood, it will be very, very significant to us going ahead, but again it's to be determined.

Fred Ziegel - Soleil Securities

Really, yes. With the June, 2008 IP version 6 deadline, what are you seeing as it relates to that? I think I just saw you were one of the first wave of certified products. What are you seeing there?

John McNulty

Yes, again it's a government mandate to move to IPB-6 on all government networks by June, 2008. I think that's what you're talking about, right?

Fred Ziegel - Soleil Securities

Correct.

John McNulty

And again there's motivations to do that and clearly the firewall technology, Web Gateway technology, etcetera, has to support that and we do today.

The government doesn't always meet its deadlines, as we all know, so again that's something that there's lots of potential for us because obviously we have a huge installed base of Sidewinder throughout the U.S. government and then in several other friendly governments around the world.

As they upgrade, I think we will benefit and benefit significantly. But the fact that the stake in the ground is there for the end of June, '08 doesn't necessarily make it come true as far as the upgrades occurring by that time. So again that's something that gives us great opportunity and we're trying our darnedest to make it happen.

Fred Ziegel - Soleil Securities

Would a lot of that fall under maintenance and therefore the upgrade would be free to agency XYZ?

John McNulty

It depends on the version that they're at and the level of maintenance that they have for the product, so that would vary.

Fred Ziegel - Soleil Securities

Okay. All right. Thanks.

John McNulty

Okay. Thank you.

Operator

Erik Suppiger from Signal Hill, you may ask your question.

Erik Suppiger - Signal Hill

Good afternoon.

John McNulty

Hi, Erik.

Erik Suppiger - Signal Hill

Blue Coats had some very good momentum. Can you discuss a little bit about how your Webwasher 6.6, does that give you advantage in any particular feature set or prospects and how does your caching compare to what they do now right now?

Dan Ryan

Yes, it's Dan. I think, Webwasher, we think is really the only one of these Web Gateway devices whose focus or primary focus is security. Obviously, Blue Coat and others are having a lot of success and growth in the wan optimization area and areas like that. Caching is a feature of our device.

We're very competitive, we believe, with the other caching products. But the customers that buy our products, the primary reason they're buying them is for security or compliance, not for optimization and I think if it's that kind of an environment, if it's that kind of initiative, we feel very confident that we'll win those -- that business.

If it's a secondary – the security is the secondary reason for the acquisition, we don’t -- then we're going to have a dogfight, I guess. But we really are the people that have the capability of inbound and outbound security at the Web Gateway plus caching and I don't think anybody else can offer that.

Erik Suppiger - Signal Hill

Have you seen them lose focus with their security customers? Has that been an issue with the customers you're dealing with?

Dan Ryan

We have -- we think, we have a great opportunity in that base and I think we're doing everything we can to take advantage of it.

Erik Suppiger - Signal Hill

Okay. And on the messaging security front have you seen Cisco taking any new initiatives with the IronPort platform?

John McNulty

IronPort was the number one competitor 95 or more percent of the time for cipher trust, and prior to our acquisition. Since, the acquisition IronPort has been the number one competitor, at least that much of the time, and we don't see anything changing there.

I commented -- I think it was on the last earnings call that on the whole I believe that the Cisco acquisition of IronPort has made more people sit up and take notice of messaging security and if they act as a typical enterprise customer, they will go to Gartner or one of the industry analysts, documents or all their consultants and say who should I look at besides IronPort as Cisco's brought it to their attention. And we're the -- we're the players that is going to be receiving the nod 99% of the time as to who else they should look at.

Dan Ryan

One more thing I'd add, I think when we are in the deal with Cisco -- with IronPort, we're very confident in our ability to win. If we're in an enterprise messaging gateway security deal, we're very confident in our ability to win that deal and I think what our job is to get into all the deals, right?

I don't think we're losing. We're winning the deals that we get into or winning our fair share of them, let's say.

Erik Suppiger - Signal Hill

Very good. Thank you.

John McNulty

Thanks, Erik

Operator

Joe Maxa from Dougherty & Company, you may ask your question.

Joe Maxa - Dougherty & Company

Thanks. Regarding the authentication market can you give us a little more color on what you're seeing in the pipeline, any larger deals that you've had in the past with dynamite or maybe not quite that large?

And then where your best opportunities are for bigger deals like that geographically?

Tim Steinkopf

Joe, authentication continues to be a -- a solid business for us and it has lots of potential. We've done -- as we've talked about in some of the calls we've done very well in landing new accounts.

We've done very well in penetrating the real estate market with tremendous success there against the competition and we've landed some sizable deals on the -- in the financial sector.

Don't want to talk about wins before we get them, but the pipeline of IAM is strong in real estate, in financial services and really across the board and RemoteAccess continues to be a very futile market for us there, also.

So it's a healthy market. I expect it to continue that way. To an earlier question it's a mix of hard tokens and soft tokens and some of our capabilities that present the one time use password to a cell phone, et cetera.

Joe Maxa - Dougherty & Company

Are you guys in the market -- how active are you in Asian markets and in Latin America and what not?

Tim Steinkopf

Latin America was led by our penetration with Manomex and the major deployment we've had there for coming up to two years.

The Asia tends to have lots of smaller deals and threats, if you will, of huge massive deals that have been being talked about for three or four years now with not much happening, but we're tracking them like a hawk.

Joe Maxa - Dougherty & Company

Okay. Thanks a lot.

Tim Steinkopf

Okay. Thank you.

Operator

Daniel Ives from Friedman, Billings, you may ask your question.

Michael - Friedman, Billings

Hi, guys, this is actually Michael (ph) for Daniel. Most of my questions are already answered --asked and answered, but I just want to know if you're looking to increase your technology presence or footprint in different technology areas maybe to go on about -- an acquisition strategy for 2008? Thanks.

John McNulty

In 2005, when we were approaching 2006 we saw that we had a major hole in the area of messaging and the global real-time reputation system and acted upon that with the transaction with our Ciphertrust.

As we go into 2008, we're -- our market -- our view of the gateway is we've got all the major pieces and the things we'd be looking for would be nice complements to those pieces.

We don't have a glaring deficiency, if you will, in not having messaging like we were looking at this time two years ago.

So I expect that any transactions that we do would be surgical additions, if you will, of feature sets onto our existing product and potentially things that would bring more customers and revenue into the areas we're already in.

Michael - Friedman, Billings

Thanks.

John McNulty

Thank you.

Operator

Todd Raker from Deutsche Bank, you may ask your question.

Brian Thackery - Deutsche Bank

Hi, guys. This is Brian Thackery for Todd.

John McNulty

Hi, Brian.

Brian Thackery - Deutsche Bank

Quick question. On deferred revenue, if I look at the last two quarters short-term deferred has been relatively flat and most of your growth has come on the long term.

Can you talk about just some of the contract length mix issues going on there in terms of what you're seeing? Are you incentivizing the sales force of the channel all to go with more three-year contracts?

Tim Steinkopf

No, Brian, we're actually not running anything different or special for three years. We often run promos. There's one of our good competitors that I'm sure you'll think of off the top of your head that runs some three-year promos and we have to match that in the field, but that's been going on for a long time.

So there's nothing changed there. I think the key takeaway from the growth in long-term deferreds is that our customers are voting with their dollars on the road maps and what they see from the Company. They really like the road maps. They like the integration. They like what's happened with the Company and they are signing up for two and three year contracts because they're voting with their dollars on that.

Brian Thackery - Deutsche Bank

As you look at Q4, how should we think about the mix between short-term and long-term? Should we see a pickup in the short-term side as well in Q4, do you think?

Tim Steinkopf

So often in Q4 is normally an increase in deferred revenue quarter for us, historically if you look back. Again if you look at the first two or three quarters of this year, there has been a bit more of a waiting towards the long term, and more and more contracts at two and three years maintaining that one-year ratio. But I would say potentially in Q4 we should see potentially a little bit of a small up tick in the short term as well.

Brian Thackery - Deutsche Bank

Do you have a metric in terms of what percentage of your contracts are two or three years versus one year?

Tim Steinkopf

I don't have that off the top of my head, but if you just did the math between the short and long-term that would be a fairly good percentile or if you tipped that against 36 months, that would kind of be our average life.

Brian Thackery - Deutsche Bank

Okay. And then if I think back a year ago, you guys put up a pretty good Q3 and then guided conservatively for Q4 and put up a very good Q4. As you sit here today after putting up your Q3 numbers and giving a guidance for Q4, how do you feel more or less comfortable with where you sat this time last year, as you look at some of the potential in the pipeline, the macro risks today versus some of the integration risks that you had this time last year?

Tim Steinkopf

Well, Brian, without falling into the trap of you trying to guide me up to date right now on Q4 guidance, it's a greatly worded question, I would say sitting here today that I think we are more confident in our guidance today than we were a year ago, given the guidance a year ago. Having said that, we're very focused on delivering a great Q4, but we're also very focused on great execution in Q4 leading into 2008 as well.

Brian Thackery - Deutsche Bank

Okay.

John McNulty

The integration problems that we had to deal with last Q4 are not with us this Q4.

Tim Steinkopf

That's very true, yes. The focus of the team is 100% on execution. Integration type of tasks are well behind us and that's the team is 100% focused on execution.

Brian Thackery - Deutsche Bank

All right, guys. Thank you.

Tim Steinkopf

Thank you.

Operator

Katherine Egbert from Jeffries & Company, you may ask your question.

Jordan - Jefferies & Company

Hi, this is Jordan (ph) actually in for Katherine. Just get back to guidance real quick. It seems like a few others are a little more bullish on Q4. Is there anything specifically you're seeing out there that makes you more conservative?

Tim Steinkopf

Nothing particular in the markets themselves and we go through a fairly normal process in setting guidance. I'll use my golf analogy. We don't try to guide low. We don't try to guide high. We try to hit it right up to down the middle of the fairway.

Q4 is normally a good strong quarter. Certainly there are a few things going on in the world today we want to make sure we're being mindful of; the appropriation bill, things of that nature, change in the marketplace, some of the things our competitors are doing. But, we believe that we're guiding very appropriately for Q4 at this point.

Jordan - Jefferies & Company

Just a quick follow-up. Checkpoint's reporting pretty good growth from their new VPN1 product. Have you guys seen that a lot out there?

Tim Steinkopf

I'm sorry, Jordan. Your first part of your question came through very fuzzy. Could you repeat that?

Jordan - Jefferies & Company

I'm sorry. I was just asking about Checkpoint VPN1, their new product, if you guys are seeing that out and about the field a lot?

Tim Steinkopf

We are not seeing Checkpoint in the marketplace very much at all. I think that Dan's answer regarding messaging getting into deals against IronPort would hold true to Checkpoint as well. When we get into Checkpoint deals, we compete very well, very effective.

In fact, this morning there was an example of a large Fortune 500 household name was getting some advice from Gartner on their firewall environment and they want through the normal list of the large competitors, Checkpoint being one of them -- you could probably surmise the others.

And the Gartner analyst listened to what they were trying to solve as far as their network needs and the Gartner analyst said to the company, said have you guys looked at Sidewinder? You guys should really take a look at Sidewinder and that's turned into a large opportunity for us.

John McNulty

One addition to that I think is that we have many cases or instances is where Checkpoint may be an install-based firewall in an enterprise and the new firewalls that are going in are specific to applications that are critical in nature and we're going in as an entry point, solving the different problem, and really as an application-related firewall we have a unique proposition there. But I think as Tim said, if we would love to get in as many deals as we can because we feel good competing with them.

Jordan - Jefferies & Company

Thank you.

Operator

At this time I don't show any further questions. I will turn the call back to John McNulty for closing comments.

John McNulty

Thank you, operator, and thank you, ladies and gentlemen, for joining us. We'll be back to you in about 90 days with the results of Q4.

Operator

Thank you for participating in today's conference. Participants on the phone lines may disconnect at this time.

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