Blue Coat Systems F2Q08 (Qtr End 10/31/07) Earnings Call Transcript

Blue Coat Systems Inc. (BCSI)

F2Q08 (Qtr End 10/31/07) Earnings Call

November 20, 2007 8:00 am ET

Executives

Carla Chun - Director of IR

Kevin Royal - SVP and CFO

Brian NeSmith - President and CEO

Analysts

Ryan Hutchinson - WR Hambrecht

Samuel Wilson - JMP Securities

Dave Duley - Merriman Curhan Ford

Rajesh Ghai - ThinkEquity Partners

Erik Suppiger - Signal Hill

Josh Jabs - Roth Capital

Rohit Chopra - Wedbush Morgan

Scott Zeller - Needham & Company

Marianne Thornton - Smith Barney

Presentation

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Blue Coat Systems Incorporated Q2 Fiscal Year 2008 Financial Results Conference Call. At this time all lines are in a listen-only mode. Later there will be a question-and-answer session and instructions will be the given at that time. (Operator Instructions) As a reminder, today's call is being recorded.

At this time then, I would now like to turn the conference over Carla Chun. Please go ahead.

Carla Chun

Good morning and thank you all for joining us this morning. Today, Kevin Royal, Blue Coat's Senior Vice President and Chief Financial Officer will begin today's call with an overview of the financial results for the second quarter of our fiscal year 2008, which ended October 31, 2007, and the current outlook for the third quarter which ends January 31, 2008. Then, Brian NeSmith, Blue Coat's President and Chief Executive Officer will provide his commentary and other operating highlights.

As you know, we will make forward-looking statements during the course of this conference call. This includes statements regarding expectations concerning market growth and business opportunities, expectations regarding future revenues, expenses, margins, or tax rates, and other financial metrics and other matters impacting Blue Coat's financial outlook and future business. These statements are based on current expectations, and they are subject to a number of risks, uncertainties and other factors that may cause industry and market trends or our actual results, level of activity, performance or achievements expressed or implied by these statements, to differ materially.

We refer you to the risk factors referenced in our press release issued earlier today, as well as the documents that the Company files with the Securities and Exchange Commission, including our Annual Report on Form 10-K. These documents identify and discuss important factors that could cause our actual results to differ materially from those contained in our forward-looking statements and projections.

Now, I will turn the call over to Kevin.

Kevin Royal

Thank you, Carla. Today, we're pleased to announce another quarter of record net revenue, including the product and service revenue of $73.4 million for the second fiscal quarter of 2008. It was an 18% increase, compared to revenue of $62.4 million reported in the prior quarter, included in the $73.4 million of net revenue as product revenue of $56.7 million, which includes sales of appliances and Blue Coat WebFilter. The $56.7 million of product revenue in the second quarter of fiscal 2008 reflects an 18% increase, compared to $48.1 million in the prior quarter. This increase is primarily due to continued strength in both security and WAN application delivery.

During the quarter, we also continue to make progress in the WAN application delivery market, with bookings in excess of $34 million for the quarter, a 31% increased compared to $26 million of bookings in the prior quarter. As Brian will discuss, we are observing a growing number of purchase decisions based on both security and acceleration functionality. However, our continuing growth in the application delivery market is to estimate our commitment to this market.

As you are aware, there is not a shortage of competitors in this space. Our differentiation is resonating well with enterprises and driving our success in this market. As I mentioned, product revenue also includes revenue recognized on sales of Blue Coat WebFilter, which increased 15% to $9.4 million in the second fiscal quarter, compared to $8.1 million in the first quarter. Approximately, $7.7 million of the revenue recognized on Blue Coat WebFilter this quarter is related to perpetual licenses, compared to $5.9 million in the first quarter of fiscal 2008.

Now, turning to service revenue, we recognized $16.7 million in the second quarter, a 17% increase over $14.3 million recognized in the prior quarter. On a geographic basis, net revenue in North America was $40.7 million, representing approximately 55% of total revenue. Net revenue in EMEA and Latin America was $24.3 million representing approximately 33% of total revenue and net revenue in the Asia Pacific region was $8.4 million, representing approximately 11% of total revenue.

Gross margin on a non-GAAP basis increased to 78.7% in the second fiscal quarter, from 77.9% in the prior quarter, due to strong pricing and our product mix favoring higher margin products such as Blue Coat WebFilter. Although, we anticipate pricing pressure in the WAN Application Delivery market, which has not significantly impacted us at this point.

On a non-GAAP basis, operating expenses increased approximately $5.1 million to $46.3 million in the second quarter. However, as a percentage of total revenue, operating expenses declined by approximately 3%.

R&D expense increased by approximately $1.5 million, but was essentially flat as a percentage of net revenue. As we stated in last quarter, we expect R&D spending to continue to increase in absolute dollars. However, we intent to maintain R&D spending as a percentage of net revenues, at approximately 15% of net revenues, for the remainder of the fiscal year.

Sales and marketing expense increased by approximately $3 million, but decreased approximately 2.4%, as a percentage of net revenue. The increase in the sales and marketing expense is consistent with increased headcounts, to expand our sales force. In fact, the number of sales teams increased from 79 at the end of the first quarter to 87 teams at the end of the second quarter.

G&A expense increased approximately $600,000 from the prior quarter, and was essentially flat as a percentage of net revenue. On a non-GAAP basis, the company reported net income of $12.4 million or $0.30 per diluted share in the second fiscal quarter of 2008, compared to non-GAAP net income of $8.3 million or $0.21 per diluted share in the prior quarter. For purposes of calculating non-GAAP earnings per share for the quarter ended October 31, 2007, our fully diluted shares were approximately $40.8 million reflecting the stock split that occurred on October 4, 2007.

On a GAAP basis, the company reported net income of $6.7 million or $0.17 per diluted share in the second fiscal quarter of 2008, compared to net income of $2.6 million or $0.07 per diluted share in the prior quarter. As a remainder, a reconciliation of non-GAAP to GAAP financial measures is included in today's press release.

Turning to the balance sheet, we ended the quarter with cash, restricted cash, and short-term investments of approximately $152.4 million, representing an increase of $34.4 million from the prior quarter. Operating cash flow in the second fiscal quarter was $19.2 million, compared to $12.1 million in the prior quarter. Capital expenditures were $1.4 million for the first fiscal quarter, and depreciation and amortization was $1.8 million. In addition, the net proceeds from the issuance of common stock, primarily as a result of the exercise of stock options, totaled approximately $16.4 million.

The accounts receivable balance increased to $40.3 million due to the increase in revenue. DSO's declined to 45 days at the end of the second fiscal quarter. The net increase in deferred revenue was $8.6 million from the prior quarter. Included in that net increase was approximately $1.7 million, which was associated with ratable revenue recognized on the Blue Coat WebFilter. Approximately $6.8 million of deferred revenue related to WebFilter subscriptions remains.

During the second quarter, the 42,060 convertible preferred shares held by Francisco Partners and Sequoia Capital were converted into approximately $4.8 million common shares. There are no longer any preferred shares outstanding.

Turning to our guidance for the third fiscal quarter of 2008 ending January 31, 2008, the company currently anticipates net revenue in the range of $78 million to $81 million. On a non-GAAP basis which excludes the amortization of intangible assets, stock-based compensation expense and expenses associated with our stock option investigation, earnings per share is expected to be $0.31 to $0.35 per diluted share. For planning purposes, we are currently forecasting a tax rate of 5% for the remainder of fiscal 2008.

As of the end of the second quarter, the valuation allowance was applied against substantially all of the company's net deferred tax assets. Due to the company's continued profitability, we may need to reverse that valuation allowance in the future. This reversal will cause a significant non-cash increase in earnings in the period if the reversal occurs. Subsequent to the reversal of the valuation allowance, we are anticipating a higher effective tax rate of approximately 30% on an accrual basis. As it is uncertain when it might be necessary to reverse the deferred tax valuation allowance, we are using an effective tax rate of 30% for fiscal 2009 planning purposes. We expect the cash basis tax rate to lag the accrual basis tax rate for several periods.

Now, let me turn it over to Brian for his perspective on the quarter and our business, going forward.

Brian Nesmith

Thank you, Kevin. Good morning everyone and thank you for joining us at the start of this holiday season. It's been another good quarter for Blue Coat. We can attribute this primarily to our continued momentum in the WAN Application Delivery market. We saw our WAN Application Delivery solutions grow from approximately $26 million bookings last quarter, to over $34 million in bookings this quarter.

During the past year, we have highlighted that we see our traditional market for Gateway Security products merging with our WAN optimization functionality into a new market called WAN Application Delivery. It is getting increasingly difficult for us to break out revenue into one category or another. The majority of the WAN Application Delivery bookings this quarter included some significant security or policy capability. A fair amount of our security customers use our platform for more than security to help accelerate their business critical, internet-based services and applications.

Are we a security company with acceleration or WAN optimization company with security? Clearly, we are both and our customers are buying our products for the combination of this functionality. Because of this, we do not intend to break out the bookings, going forward, and we guide investors to look at our overall revenue growth to indicate how well we are doing in the WAN Application Delivery market.

Over a year ago, when we entered the market, we highlighted that WAN optimization would evolve from a tactical issue related to application performance between data centers and remote branch locations, to an overall solution for security and acceleration at business applications. Corporate trends around the centralization and web application enterprise caused significant performance segregation, where some applications can take a minute or more to respond, rendering the applications essentially unusable.

Today, the WAN infrastructure is a strategic consideration when enterprises deploy applications and allow [WAN] optimization solution is a key part of their WAN infrastructure. As enterprises become more virtualized, services beyond acceleration become important. If a mission critical application travels across the WAN, it is essential to assure the integrity of that application and to control who uses it, and how it is used. Additionally, many customers are using their internet as their WAN and require security as a part of their direct to the net architectural solution. These requirements are best addressed by moving beyond WAN optimization to WAN Application Delivery.

First, WAN Application Delivery must cleanly fit within the enterprise network, including everything from authentication to routing, network monitoring management and security. It must scale to reach all of the enterprise locations, often up to hundreds of sites. Second, the solution must provide intelligence in controlling the network. This requires two key competencies, the ability to identify and understand users and applications, and their ability to control the interactions between them. Third, WAN Application Delivery requires the ability to manage the full range of business applications. This includes enterprise video and encrypted applications. It is becoming increasingly important for an enterprise to be able to distribute video throughout the organization, both live and stored.

We have seen a substantial increase in customer requirements for video delivery. It also includes the ability to see and manage or accelerate what would otherwise be invisible SSL-encrypted traffic. This is especially important with the rise of software as a service, where enterprise is dependent on externally hosted software that communicates across the internet using SSL encryption.

And finally, something we have talked about in the past, WAN Application Delivery includes the ability to expand application delivery to remote employees, regardless of the location. In another words, it's the ability to provide web security and forced corporate policies and accelerate business-critical applications, using a software-based client that can be loaded on employees' laptop computers.

We continue to evolve our products and technology. For instance, just yesterday, we announced Extended Authentication for our ProxySG Appliance. It is already well recognized for the variety of authentication systems it supports and the richness and flexibility that out-manages those systems. Yesterday's announcement describes how we are expanding both the types of authentication we support and the way we manage it.

Authentication, as you may know, is the processes of verifying a network user's identity. Verified identity is essential to grant or limit access to certain applications, determine network priority and bandwidth, assign group membership, and apply other permissions or controls. Knowledge of the user is important for web security and control deployments, but is also important for WAN Application Delivery.

Authentication enables acceleration or prioritization of traffic to be performed, based on the individual or the group to which the individual belongs, as well as the type of application the individual is using. Different individuals or groups will have different privileges and levels of access. A salesperson in a branch office, for instance, may have a higher priority than a staff marketing employee, in accessing the company's centralized Customer Relationship Management system.

Last week, we announced our participation in SAS Partner Program. Together with SAP, we have conducted joined testing using ProxySG Appliances to accelerate SAP applications across simulated WAN environments, and witnessed dramatic performance results of up to 97 times faster response time. In addition, only ProxySG Appliances can exceed and accelerate transactions using SSL encryption and SAP saw this as an important differentiator.

It is clear that the market is evolving and the customers are demanding more robust solutions to accelerate, secure and manage their enterprises. Yesterday's WAN optimization is no longer good enough. WAN Application Delivery is the stage of the market today. We believe that we have a considerable advantage in this new and still evolving market, and we believe that we are well-positioned to meet the new market requirements with a superior solution to ProxySG Appliance. I think probably a simpler way of stating this is to remember Blue Coat stops the bad, and accelerates the good.

Again, I would like to thank everyone for listening in today, and I'll turn the call back over to Carla.

Carla Chun

Thank you, Brian. That concludes our prepared remarks this morning. We will now turn the call over to Ken for questions.

Question-and-Answer Session

Operator

Great, thank you very much. (Operator Instructions) And our first question, then, this morning comes from the line of Ryan Hutchinson with WR Hambrecht. Please go ahead.

Ryan Hutchinson - WR Hambrecht

Good morning. Congratulations on the quarter and the guide. A few questions here. Can you talk to the pipeline for the WAN optimization business at the end of the quarter?

Brian NeSmith

I know we recently talked about it in some detail. We don't think--we've basically started--I don't think we're going to keep breaking that out. So, we look at the overall pipeline which was better from what we have, but I actually don't know the exact number. I think we tried to highlight in the call, Ryan, that there is something, it's worth understanding here, it's getting more difficult for us to just classify something in one category or another.

Ryan Hutchinson - WR Hambrecht

Understood, but I am assuming it's certainly north of the $100 million you highlighted on last quarter's call?

Brian NeSmith

Yes, it is.

Ryan Hutchinson - WR Hambrecht

Okay. In terms of the financial exposure, can you talk to whether or not that negatively impacted you in the quarter, or do you expect it to, in the coming quarter…and perhaps, just provide maybe, a general sense of the exposure you have to that vertical?

Brian NeSmith

I assume what you are talking about is just everything going out with the sub-prime market…

Ryan Hutchinson - WR Hambrecht

Correct.

Brian NeSmith

…and everything around that area. One thing, I think that's worth highlighting is--one is that, we don't have, financials are good segment for us; and even this last quarter, we saw a fair amount of activity with some larger financial services firms. So, I am not, we haven't seen as much of a fall out related to that activity around that area. That being said, we also are not in any way concentrated, I guess, with financial services. We do a lot of business outside of the financial services sector and government, healthcare, pharmaceuticals, manufacturing--you name it--just about every segment.

The other, I think, very relevant piece to is that, our solutions, for a number of customers can be justified from a standpoint of Return on Investment that can be measured in a matter of months, which means that, in a lot of cases, we are actually at cost saving solutions for a lot of those customers. So, I am not going to say that we're immune to what's going on there, it is, clearly, we are not, but we haven't seen anything that would, first of all, as our exposure to that market and as far as our forecast for our business going forward.

Ryan Hutchinson - WR Hambrecht

Okay. And then in terms of the MACH5 Edition that you unveiled recently. Can you talk about the pricing compared to the core proxy offering and the interest levels to date, and even more importantly, perhaps the uptake in any early successes there?

Brian NeSmith

The price difference between the MACH5 Edition and the Proxy edition of the ProxySG ranges anywhere from 25% to about 40%, last hitting on the actual platform. What happens, as we use the MACH5 Edition, in a lot of cases, as part of the bidding process, and explain to customers that when they want to do an apples-to-apples comparison of our product to one of our competitors products, that the MACH5 Edition it's pricing is more appropriate. But what ends up, what the customer ends up purchasing in the majority of cases, we've seen so far, as a lot evaluation occurs around the MACH5 Edition, and then for reasons of around design some other piece of functionality, a good majority of the customers still under purchasing the proxy edition, I think in the last quarter, I've said the amount of uptake we saw in the MACH5 Edition was nominal, at best. It wasn't a huge amount of volume in the quarter, and I wouldn't expect it to be a lot of volume going forward as well. A lot of it is about the selling dynamic and allowing us to do a more apples-to-apples comparison to our competitors.

Ryan Hutchinson - WR Hambrecht

Understood. And then, finally, one for Kevin. Jus… on the both-- the gross margins and the operating margins came in well ahead of expectations. First of all, I just wanted to get a better understanding how we should think about gross margins over the next couple of quarters. And then, obviously, the operating leverage is surfacing here but how should we think about that from an investment spend perspective over the next several quarters as well? And that's it for me, thanks.

Kevin Royal

So, I think from an operating expense standpoint, we'll continue to improve our operating expense as a percentage of net revenue. As far as gross profit, we did have a very strong gross profit in the quarter and we had expected when we forecast the quarter to encounter pricing erosion related to the WAN Application Delivery market, we did not encounter that in the quarter. But we do expect gross profit margins to be slightly down from what we reported in the second quarter and for our modeling purposes, we are using gross profit of 77.5%.

Ryan Hutchinson - WR Hambrecht

Okay, great. Thank you.

Operator

Thanks. And our next question that comes from the line of Samuel Wilson with JMP Securities. Please go ahead.

Samuel Wilson - JMP Securities

Good afternoon, everyone. Also, just a few very small questions. Two for Brian, can you describe the overall WAN optimization market in the sense that are, bluntly asking, is the market accelerating, decelerating? And what your sense on the overall growth--more customer activity, the same amount that you saw maybe 90 days ago, or six months ago?

Brian NeSmith

I think it's probably a little bit of an acceleration from what we saw last quarter. I wouldn't say substance so. The activity level is increasing for us, especially in the larger enterprise environments, and as we get better known for solutions in the space, I would say there is slight acceleration.

Samuel Wilson - JMP Securities

Awesome. And then, do you know if any changes in the market between the domestic market versus the international market?

Brian NeSmith

I don't, nothing that I can think of that, but standout, there is nothing like that I think of, Sam.

Samuel Wilson - JMP Securities

Perfect. And then, just one for Kevin, just what's headcount, I missed it?

Kevin Royal

See, we added 62 during the quarter, bringing our regular full time headcount to 815. We also had 30 temporary and contract employees at the end of the quarter. So, our total headcount in the quarter was 845.

Samuel Wilson - JMP Securities

Thank you so much. Great quarter, gentlemen.

Operator

Thank you. And our next question then comes from the line of Dave Duley with Merriman Curhan Ford. Please go ahead.

Dave Duley - Merriman Curhan Ford

Yes, congratulations on a nice quarter. First question from me is, similar to the question that the person just asked, on the WAN optimization front, it seems like the growth of the business there is slowing a bit, and clearly your competitors are, its growth rate slow, and I was wondering if you might talk a little bit to about the trends that you are seeing in that respect?

Brian NeSmith

I am not sure, I would agree that I think that the market is slowing. I think its clear the market is getting is more competitive, and I think that we're a big contributor to that equation for a lot of companies in that space. There are a lot of people interested in this technology, a lot of the purchases that we're seeing are growing larger, which means that, people are doing more thorough evaluation, but I don't see a slowdown in the overall space that we're playing out the WAN application delivery, and I see a lot of activity, and if anything from our standpoint actually, we just probably see the activity strengthening not weakening.

Dave Duley - Merriman Curhan Ford

So, in regards to Riverbed, who has a much different channel than you do, and it seems like you have an advantage of, so to speak, mining the current customer base that you have on the security side and is that providing you with a large bundle of business to attack, whereas your competitor who has clearly seen its grow slow was up 25% and it was up 17%, they guided only up to 10% sequentially. Is that a matter of the customer base they are serving and the channel they are serving as to why your growth looks different than theirs?

Brian NeSmith

I can't totally speak to it, what's driving, the fundamentals of their company. What I do know from our standpoint is that, its often times of struggle to get the right balance for how much you invest in the business for future growth versus how much you drive for profitability and striking the right balance for that when you are in a higher growth situation is a challenge for any company, and we've clearly lived it in our past history. I think, in a lot of the cases here, we've seen a lot of the opportunity we made investments several years ago. We continue to make investments in a way that I think, can fund and drive that sustained growth.

We also, I think, are a bit different than the pure play WAN optimization vendors in that with the CDN video streaming capabilities, with the ability to accelerate encrypted traffic and all types of encrypted traffic, not just the ones that you can control the certificates and the security and the policy capabilities, they were not purely a vendor that's about acceleration. And so, I think that also creates a bit of different dynamic in what we're doing.

We bring up, I think, a broader solution than a lot of our competitors in the WAN optimization space. And so, we are not entirely dependent upon our value propositions of simply just accelerating business applications.

Dave Duley - Merriman Curhan Ford

Okay. One question on the margin front, I believe, in the quarter that we just reported, you were guiding margins down and margins came up and up, and I've seen, to recollect that when you are guiding margins down you thought you would see some price pressure when you introduced the MACH5 kind of WAN only optimization product. And so, you are thinking there was that margins will go down. Clearly, the mix of business and the margins didn't go down. So, I was wondering what kind of is the surprise factor here, how come, so to speak, you are not seeing the margin pressure that you anticipated initially?

Brian NeSmith

A couple of things. One is, I think that--I think, doing a little bit better than we expected with Blue Coat WebFilter, which obviously has a good positive impact on margins. The other part, two is, with the introduction of MACH5 Edition. What we didn't, and we still, I'm not sure have a completely good idea of what's going to happen, but we didn't expect is that the customers that we were selling WAN optimization to, as we were doing an apples-to-apples comparison to our competitors MACH5 Edition-- a substantive portion of those customers actually bought proxy edition, which means that the lower price products and lower margin products didn't have as a big an impact as we might have expected during the quarter. We still, I think, there is a bit of uncertainty around that, and as we go forward there's still going to be a fact on what we are doing. And obviously, as part of our sales process, we encourage our customers to make the upgrade to fully loaded product and all the value that it brings. But that's the part of the factors that are helping drive that gross margin.

Dave Duley - Merriman Curhan Ford

So, kind of, to say it another way, you thought you'd have an uptake on a lower margin product that secure WAN only and they are choosing the kind of Combo products that has higher margins and some more differentiated products for yield.

Brian NeSmith

That, and I think the Blue Coat WebFilter, yes.

Dave Duley - Merriman Curhan Ford

Okay. Final thing from me. Can you maybe update us on your target model, do you have any update there as to what levels of revenue to achieve that target model or anything around that?

Kevin Royal

So, the target model in the near term is 20% operating profit, long-term would be 25% operating profit, and we have not in the past, and where we today give a revenue level and when we expect to achieve that.

Dave Duley - Merriman Curhan Ford

And what near term means within a year then?

Kevin Royal

Again, Dave, we don't give a timeframe on that or a revenue level.

Dave Duley - Merriman Curhan Ford

Thanks.

Operator

Thank you. And our next question then comes from the line of Jonathan Ruykhaver with ThinkEquity Partners. Please go ahead.

Rajesh Ghai - ThinkEquity Partners

Hi, this is Rajesh Ghai, for Jonathan. Congratulations, again. One question on the competitive landscape. Are you still seeing the likes of Riverbed, Cisco in most competitive situations or…

Brian NeSmith

No, I am sorry.

Rajesh Ghai - ThinkEquity Partners

And also just wanted to know what your win rates were in the quarter?

Brian NeSmith

I don't think the competitive dynamic has changed much; its CISCO and Riverbed and, to some extent, Juniper and what we're seeing in the market. I think our win rates are staying fairly consistent with what we've seen before. I actually don't know the exact numbers, I didn't calculate in this last quarter in any kind of detail, so I couldn't tell you that, but I haven't seen as much of a change from over the last couple of quarters.

Rajesh Ghai - ThinkEquity Partners

And in terms of RFP activity, are you seeing an increase in the combined solution requirement in terms of WAN optimization of security or are you kind of seeing no change?

Brian NeSmith

We as a company, even when our customer asks for a pure WAN optimization solution, a pure WAN optimization solution will as part of our sales activity try to show the customer how some of the other value propositions can affect their enterprise. So, even when the customers are buying pure WAN optimization, we tend to work pretty hard to turn that into a broader WAN Application Delivery sale, and are generally, fairly successful with that. And so, I would say that, I don't actually know and couldn't delineate what we see from customers when they are asking for pure WAN-op versus something broader and the original request. It's a little blurry for us to be able to tell that because our sales people, even in the initial qualification will start talking about some of the capabilities and will muddy the waters there and drive customers, and helping them to understand that if there is a broader set of capabilities available for them in this market. And so, I would say in general, I don't know if we could answer that question specifically and it's mainly because we focus on the broader solution set.

Rajesh Ghai - ThinkEquity Partners

Okay, thank you so much.

Brian NeSmith

Thank you.

Operator

Thank you. And our, I am sorry, please go ahead.

Brian NeSmith

That's all for me, thank you.

Operator

Okay. Great, thank you. We're going to go then to a question from the line of Erik Suppiger with Signal Hill. Please go ahead.

Erik Suppiger - Signal Hill

Good morning, congratulations.

Brian NeSmith

Thanks, Erik.

Erik Suppiger - Signal Hill

First of, can you give us a little more color in terms of the size of deals you are wining on the WAN Application Delivery. You talked about getting some better success within the enterprise. Can you give us a feeling for where some of your largest deployments are at this point?

Brian NeSmith

I think in the last quarter, we had a one or two north of a million, we had several in kind of 250 million to a 1 million range in a bunch and that kind of 100K to 300K range. So, they tend to be a bit bigger than our average on the gateway side of the business probably by a factor of two or three on average.

Erik Suppiger - Signal Hill

Yeah, and for the ones that are $1 million, how many units would that be?

Brian NeSmith

Just thinking through the two lines I know of exactly, one of them I think is roughly around 80 units and the other one's a little bit north of just under a 100 units.

Erik Suppiger - Signal Hill

Okay. And how far along are those early in the rollout phase or is that the majority of the rollout or how big are the potential on some of the big deals you are working on?

Brian NeSmith

Those in particular, that's probably their entire rollout other than, they are not doing anything with the client at this point in time but that's probably from there for the two that we just talked about it, that's probably the majority of their rollout. Customers, they are all over the map as to whether they do a small purchase upfront and then buy overtime where they buy in both upfront.

Erik Suppiger - Signal Hill

Okay. And on the hiring front, you added a good number of sales people. What is the environment right now, there is seems to be a lot of hiring across the board? What availability are you seeing out there in terms of hiring?

Brian NeSmith

As far as hiring sales people or hiring in general?

Erik Suppiger - Signal Hill

Sales people, in particular, but comments on the others is good too.

Brian NeSmith

Yeah, so far I would say we're seeing a lot of good activity around hiring sales people right now. In general the market, there is lot of attractive people that I think have the profile for what we are looking for. More broadly speaking, I think that hiring in the Valley is getting a little bit more interesting in the last six months from the standpoint of talent is competitive. Given that we have R&D facilities outside the Valley, we also do a fair amount of hiring there. So that relives somewhat of the pressure that we see in that area but nothing like we saw on the bubble days, that's for sure.

Erik Suppiger - Signal Hill

Okay. And then lastly Kevin, What WebFilter, how much revenue from the deferred revenue for WebFilter are you expecting in the next quarter?

Kevin Royal

I think in the third quarter it will be about a $1 million.

Erik Suppiger - Signal Hill

So, it will go from the $1.7 million down to a $1 million.

Kevin Royal

That's right

Erik Suppiger - Signal Hill

And what would you expected to do after that?

Kevin Royal

After that it will trail slowly up over the next four quarters. It won't be a meaningful contribution to revenues in our fiscal year 2009.

Erik Suppiger - Signal Hill

Okay, Very good. Well, congratulations. Thank you.

Operator

Thanks. And our next question then comes from the line of Josh Jabs with Roth Capital. Please go ahead.

Josh Jabs - Roth Capital

Hi, good morning. Can you give us a sense of the mix of MACH5 sales to the legacy Blue Coat and NetCash customers versus new customers?

Brian NeSmith

I can't, I'm thinking whether I can, I couldn't tell you any special mix. I don't quite think of it that way. I know we sold some to the some of NetCash customers and a fair number through out install base, so there is no special concentration there.

Josh Jabs - Roth Capital

Okay. So, you are not, I mean, I'm thinking may be not last quarter but then in previous call you kind of said that, it was may be even 50-50 to new customers versus legacy customers?

Brian NeSmith

Yeah, I think we're probably falling into, probably, a similar ratio to the volume of the installed base. We look at the NetCash customers as almost similar to the way we look at our installed based customers. And so…

Josh Jabs - Roth Capital

I am sorry Brian. I mean, if I include NetCash with the legacy Blue Coat customers, so, all that -- consider that your installed base versus customers outside of that installed base, well that's actually the ratio, I'm looking for?

Brian NeSmith

Okay. That part, I couldn't tell you the exact number but just to off the cut estimate, it's definitely like two-thirds or more or probably installed base.

Josh Jabs - Roth Capital

And how far would you say yours is a process of have been into that installed base?

Brian NeSmith

Not heavy into it yet.

Josh Jabs - Roth Capital

Okay, that's helpful. And then, on the book-to-bill on the WAD side versus the legacy product sales, are there any real differences there?

Brian NeSmith

Not really, our business -- that is our business. So to some extent you can look at the WAD business and our, the overall company is evolving into being exactly the same sort of business.

Josh Jabs - Roth Capital

Okay. And then Kevin, can you repeat the WebFilter contribution in the quarter?

Kevin Royal

Yeah, the WebFilter contribution in the quarter was about $9.4 million.

Josh Jabs - Roth Capital

Okay. And then, last one here, Kevin you said you're modeling 77.5% sort of in your own projections?

Kevin Royal

Right.

Josh Jabs - Roth Capital

On the gross profit side--is that for next quarter? Did you say that sort of sustainable may be in near term over the next few quarters?

Kevin Royal

That's only for next quarter. We only give guidance for one quarter at a time.

Josh Jabs - Roth Capital

Okay. So, I mean, to be safe, if pricing pressure does come into play at some point here, I mean, can we still look sort of back at the type of margins that you've had on appliances in the past as being sustainable, so it may be slightly better than that given you sign additional software as module here? I mean is it a 76%, 75% model long-term, where do you see that breakdown?

Kevin Royal

It's difficult to determine given that we're talking about price competition. We've modeled it several different ways. Last quarter, we thought we end up around 76%. So, it is difficult and as we get visibility we'll, of course, give insight as that's available.

Josh Jabs - Roth Capital

Alright, good quarter. Thanks guys.

Operator

Thank you. And our next question then comes from the line of Rohit Chopra with Wedbush Morgan. Please go ahead.

Rohit Chopra - Wedbush Morgan

Thank you. I just had heard during the quarter that the sales cycle had begun to extend just a little bit. Have you seen anything similar to that? Some people have told me that 30 to 60 days things have changed a little bit out there?

Brian NeSmith

I haven't seen any change in and what's going on as far as sale cycle.

Rohit Chopra - Wedbush Morgan

Okay. And can you tell me what the linearity was like in the quarter?

Brian NeSmith

I think the linearity was fairly normal. It wasn't really impacted in the quarter.

Rohit Chopra - Wedbush Morgan

And the other thing I wanted to ask is that, there is Riverbed talks a lot about their client and I remember coming to your offices and there was a demo of the client, have you noticed that people are actually demanding that as a part of the product that you are selling, is that part of the sale?

Brian NeSmith

I think there are two parts to that; two answers to that question. The first is, for the customer that is definitely looking for something to deal with a desktop solution, it's absolutely a big deal. And in that situation, very important that we provide that capability and we demonstrate that to the customer.

And we're continuing to make investments in the functionality and capability of that product, both on the acceleration and the security side from a functionality perspective. But the other part, I think is, even for the customer that is not looking for a client right now, it is a checkbox feature for a lot of those customers to know that they are protected at a point in the future that they may need a client, and knowing that we provide that, I think, as a big part of enablement of our core ProxySG business, we're selling boxes to those remote brands locations. So that most of those are factors in the equation.

It's still, and I think I have said multiple times, I view the client as more a feature than I do something that's going to enable a lot of future revenue, and it enables revenue from the standpoint of helping our customers by more of our ProxySGs. But the client is an essential part of the solution, but not one that I think that's going to be a big driver of incremental revenue.

Rohit Chopra - Wedbush Morgan

Lastly, there were a couple of companies in the quarter who reported, who had indicated where they wanted to go with their WAN products, is there anything you see that you need to be doing to augment it's capabilities over the next six or twelve months something that's not there for example?

Brian NeSmith

Rohit, there are incremental features that we want to continue to add, so it's not a static place from a standpoint of new functionality. There is both acceleration features and security features. And you look on a security side, we're definitely seeing a lot of activity around Web 2.0 software as a service, a variety of different things in that area on the acceleration side of things. There is a lot of functionality around new types of applications, challenges what Microsoft protocols. There is also a lot of incremental work on our part around the SG client and features and capabilities that we're adding in the product, as well. So, I don't know if you are alluding to, if there was something that we need to acquire from a technology standpoint or do we feel like how competitive our product is, and I am not quite sure, what the gist of your question is going.

Rohit Chopra - Wedbush Morgan

It was more of just functionality. I mean, you could answer it any way you wanted to.

Brian NeSmith

Okay.

Rohit Chopra - Wedbush Morgan

Thank you. I appreciate it.

Brian NeSmith

Yes.

Operator

Thanks. And our next question then comes from the line of Scott Zeller with Needham & Company. Please go ahead.

Scott Zeller - Needham & Company

Thank you. I wanted to ask about the tax rate change that you had mentioned. It sounds like, we maybe modeling this on a ramp-up basis through fiscal '09, but not unlikely going to 30%?

Brian NeSmith

That's right, in fiscal '09….

Scott Zeller - Needham & Company

Fiscal '09--ramping to finish fiscal '09 around 30%?

Brian NeSmith

That's right.

Scott Zeller - Needham & Company

Okay. And then, Brian, on the competitive landscape. You know, we've heard the other names, but could you tell us, though, when you look at all of the deals, how many of them are uncontested, just a rough guesstimate, is it like 30% or any idea?

Brian NeSmith

It's at the lower end of our scale. I think the vast majority of what we're seeing is our deals that are more contested than not. So, it's probably less than 25% that are uncontested.

Scott Zeller - Needham & Company

So less than 25%. Has that changed materially quarter-to-quarter?

Brian NeSmith

It's getting lower every quarter; that's not a big jump, but just, I think, gradually going down to the fact where, I expect just we get another year, I think everything will be contested.

Scott Zeller - Needham & Company

Okay. Then the last one is, if you, and this is just another guesstimates, you disclosed the bookings, I know for WDS, but could you tell us, just from your viewpoint as management, how many quarters, you now, believe you had material actual revenue from MACH5 influence? Would you say we're three quarters into like noticeable revenue contribution or how would you estimate that because we've heard about bookings, but as far as actual revenue contribution?

Brian NeSmith

I think four quarters.

Scott Zeller - Needham & Company

Four quarters end for material contribution.

Brian NeSmith

Maybe five, but I think four.

Scott Zeller - Needham & Company

Okay. Thanks very much.

Operator

Thanks. And our next question then comes from the line of [Marianne Thornton] with Smith Barney. Please go ahead.

Marianne Thornton - Smith Barney

Hi, yes good morning. Thanks for the news this morning, and the call and one of my questions has already been answered, and the second one is, could you just speak briefly to geography of sales, and in particular if you see continuous exploration outside of North America?

Brian NeSmith

We've been making--I think we've highlighted, and this is probably more related to Blue Coat than it is the overall macroeconomic market--that we've been making significant investments in Asia Pacific, and expanding what we are doing in that region, and we've seen with that the growth that comes along with those investments, from a geography standpoint over the last year, and probably the only thing that's distinct or unique. In general, in any one quarter, we will see a surge in a geography, as it gets averaged that across a couple of quarters. It's generally consistent across all the regions coincident with the amount of investment we make in that region.

Marianne Thornton - Smith Barney

Okay. Thank you. I appreciate it.

Operator

Thanks, and at this time and we have no further questions in queue.

Carla Chun

Great. Again, we would like to thank all of you for joining us this morning on the call and I'd like to remind you that a replay of today's call will be available at area code 320-365-3844 with the pass code 893289 beginning today at 11:30 a.m. Eastern Time and an audio archive is also available on our website. We hope you have a great holiday and we look forward to speaking with you again soon.

Operator

Thank you. And ladies and gentlemen, that does conclude our conference for today. Thanks for your participation and for using AT&T's Executive Teleconference. You may now disconnect.

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