Secure Computing Corporation Q1 2008 Earnings Call Transcript

Secure Computing Corporation (SCUR)

Q1 2008 Earnings Call Transcript

May 1, 2008 4:30 pm ET

Executives

Jane Underwood – VP of IR

Dan Ryan – President, CEO and COO

Tim Steinkopf – SVP of Operations and CFO

Analysts

Joel Fishbein – Lazard

Eric Martinuzzi – Craig-Hallum

Bob Owens – Pacific Crest Securities

Jonathan Ruykhaver – ThinkPanmure

Fred Ziegel – Soleil Securities

Josh Jabs – Roth Capital

Fred Green [ph] – Goldman Sachs

Joe Maxa – Dougherty & Co.

Katherine Egbert – Jefferies & Co.

Eric Suppiger – Signal Hill

Todd Raker – Deutsche Bank

Presentation

Operator

Welcome to Secure Computing Corporation's first quarter 2008 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 call is being recorded. If there are any objections, please disconnect at this time. I will now turn the call over to Ms. Jane Underwood, Vice President for Investor Relations.

Jane Underwood

Good afternoon. And thanks for joining us to discuss our first quarter results. On the call with me today are Dan Ryan, our CEO and Tim Steinkopf, our Senior Vice President of Operations and CFO. Before I turn the call 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 that involve risks and uncertainties. Such forward-looking statements are subject to the Safe Harbor created by the Private Securities Litigation Reform Act of 1995. These statements include, for example, statements regarding future results such as guidance for second quarter billings, revenue, gross margin, operating expense, tax expense, interest and other expense, expense reductions, shares outstanding, earnings per share and cash flows and cash balances and statements about our sales pipeline, the breakdown of sales across our product lines, and success and availability of our products. Our actual results could differ materially from the forward-looking statements. Factors which could cause actual results to differ include, for example, risks related to the competition in the securities industry, changes in customer requirements, delays in product development, and the other factors and risks identified in our press release and our SEC filings. We do not undertake any obligation to correct or update any forward-looking statements that may become inaccurate.

Now, I would like the turn the call over to Tim.

Tim Steinkopf

Thank you, Jane. Since our final Q1 results are consistent with the preliminary results that we announced on April 7th, we'll briefly review the highlights for the quarter and then spend some time discussing a few cost-saving measures that we undertook this past week.

As a reminder, non-GAAP financial measures are reconciled to GAAP in the table at the end of today's press release. Non-GAAP revenue for the first quarter was $65.7 million, an 8% increase over the prior year. Billings for the first quarter were $69.1 million, a 4% increase over (inaudible) year. Non-GAAP net income for Q1 was $5 million or $0.07 per fully diluted share. The shortfall relative to our guidance issued on February 4th was largely related to the two issues that we discussed on April 7th. First, our North America commercial business was significantly impacted by a combination of macroeconomic headwinds causing customers to delay purchasing decisions. Second, our U.S. Federal team fell short of their goal due to contracting delays and budgeting issues related to the continuing resolution that the government was operating under at that time. In the last six business days of the quarter, approximately $11 million of revenue from our commit line was pushed out of Q1. Importantly, our EMEA and Asia Pac teams experienced very solid performance, delivering at or close to their target.

In Q1, international billings were 41% of total billings. Domestic billings, excluding the U.S. federal government were 42% of total billing, and the U.S. federal government represented 17% of our total billing. In the first quarter, billings for our gateway security products were 86% of total billing and billings for identity and access products were 14% of total billing. In the quarter, we closed five individual transactions greater than $1 million and an additional 110 deals over $100,000. Deferred revenue increased $6.2 million or 4% sequentially. At end of March, the total deferred revenue balance was $174.4 million. As expected, non-GAAP gross margin was 75% of revenue. Non-GAAP operating income for the quarter was 10% of revenue. In Q1, we generated a $13.1 million in cash from operations. The company's cash and restricted cash balance was $23.7 million on March 31st.

Before I turn to Q2 guidance, I would like to discuss the cost-saving measures we undertook this past week. These measures included the elimination of 75 open positions that we had been planning to fill, the elimination of 75 current positions, additional reductions in non-employee-related expenses from plan levels by $500,000 per quarter, and additionally we have reduced our planned capital spending by approximately $5 million for the balance of the year. A few other items to stress. We're maintaining an appropriate headcount in investment and engineering in order to continue fostering innovation, and the steps taken should reduce our forecasted expenses for 2008 by approximately $10 million, which equates to an annual amount of approximately $14 million to $15 million.

Now, I would like to turn to our outlook guidance, which is based on current expectations. All of these statements are forward looking and actual results could differ materially. For the second quarter 2008, we expect billings to be up slightly from Q1. Non-GAAP revenue is expected to be in the range of $63 million to $67 million. Non-GAAP gross margin is anticipated to be approximately 73 to 75% 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 75 million shares. Non-GAAP tax expense, which is also approximate – our actual cash outlay for taxes is expected to be approximately $300,000 to $500,000. Interest and other expense are expected to be approximately $900,000. And Q2 non-GAAP earnings per share are expected to be approximately $0.04 to $0.07 per fully diluted share. We again expect the breakdown of our product lines in Q2 to be approximately 90% for enterprise gateway and approximately 10% for Identity and Access Management.

As in prior years, we expect to see a sequential decrease in our Q2 cash generation due to normal seasonality. In Q2, cash generated from operations is expected to be approximately $3 million to $4 million. And consistent with normal seasonality, we would expect Q3 cash generation from operations to increase to approximately $6 million to $8 million. We expect Federal billings for Q2 to account for 15 to 20% of total billings. And before I turn the call over to Dan, I would like to point out that we're suspending full year '08 and '09 guidance. Given the uncertain macroeconomic environment and the amount of deal slippage that we experienced in Q1, we believe it's prudent to only provide guidance for Q2 at this time.

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

Dan Ryan

Thank you, Tim, and good afternoon. We're disappointed with our Q1 results and are taking aggressive actions to improve our future performance. This includes restructuring described by Tim and the implementation of a growth plan that I will briefly describe now. Over the last several months, the senior management team has been developing a strategy that will allow us to better capitalize on the market opportunities before us and provide stronger top and bottom line growth. Our board of directors has endorsed this plan and we're now aggressively executing on it.

While there are certainly excellent growth opportunities for each of our product lines, I'm a big believer in focus. Our increased focus will take two forms. First, we will commit substantially more of our resources to the areas of our business where we believe we can be the clear market leader. And second, we'll narrow the scope on our remaining products to the market segments where we've proven success and an opportunity for segment leadership. Regarding the former, our simple objective is to become the clear leader in secure web gateway market over the next 18 months and to remain a leader in the e-mail gateway market. The secure web gateway is a lucrative golden opportunity, and we're already in the strong position there. According to Gartner, there's only a 10% to 15% penetration of these solutions in the enterprise and 20% to 25% annual growth is anticipated.

Hosted web security, while smaller today than appliance base, is expected to grow at 36% annually according to IDC. We plan to address the web gateway market with flexible or hybrid delivery model and that means appliance based, virtualized, and hosted or in the cloud offerings. In the coming weeks, we will launch a hosted web security service to complement our already successful appliance based offerings as well as our recently announced virtual offerings. The new SAS, or software to service offering, leverages our web gateway technology as well as the worldwide data center infrastructure that exists for TrustedSource today. We're excited about both our current situation, as this is our most successful growth area, and the ability to accelerate this opportunity based on an incremental investment combined with the high growth opportunity in the market. We remain a leader in the secure mail gateway market as well, which is another attractive growth area and one that has substantial synergies with web security. Similarly, we plan to offer flexible delivery models to our customers there.

In summary, our long-term strategy for web and mail security is to allow our customers to purchase market-leading security services and deploy them across different delivery platforms to mix and match any configuration. This will deliver service portability, common policy in reporting, and unified pricing across all delivery models. Next, with respect to narrowing our scope on the remaining products, we've an excellent franchise in secure firewall or Sidewinder, the industry's leading application firewall. Our success in government financial services and high assurance networks in regulated and other industries continues to be strong. We protect some of the world's most critical networks and applications. If there's valuable data to be protected, we're a strong solution that should be considered. Secure's firewall is also unique in that it's a software product that is readily virtualized and we will take advantage of that as well. Also, we offer the only application firewall that's fully integrated with the reputation system, our TrustedSource system. Our emphasis going forward will be to aggressively attack and lead these key segments of the broader firewall market. Similarly, with SafeWord, we've a great platform to build from with 4 million users today. Our primary emphasis will continue to be remote access solutions that can be rapidly deployed in Microsoft-centric environments.

To summarize, we've reduced our cost structure and we're substantially increasing our investment in the high-growth areas where we believe we have the opportunity for clear leadership. In the other areas, we're narrowing our scope, and we will continue to strengthen our team throughout the organization. To that end, I'm pleased to announce that Steve Kozachok will be joining Secure Computing next week as our new Senior Vice President, Secretary, and General Counsel. Steve comes to us from St. Jude Medical, where he served as Associate General Counselor for the last three years and was the primary lawyer responsible for business development efforts. Before that, Steve was a partner in law firm of Dorsey & Whitney, where he was Lead Outside Merger and Acquisition Counsel to the Fortune 50 company. I speak for the entire management team in saying we remain highly optimistic about the future of Secure.

Operator, we would now like to open the call to analysts' questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Joel Fishbein with Lazard. Your line is open.

Joel Fishbein – Lazard

Good afternoon guys. Tom, just a couple of questions. First, can you give us more color on some of the product lines, Webwasher and IronMail in particular, your secure web or secure mail, how they did in the quarter?

Tim Steinkopf

We don't typically segment them out, but I will say that the – our web gateway product line is certainly the highest growth area and is growing significantly higher than those market rate growths that we mentioned from Gartner's perspective, but beyond that we don't segment them.

Joel Fishbein – Lazard

How about in terms of the competitive landscape there? Any better, any worse?

Tim Steinkopf

I think that we are seeing the same competitors on the web gateway. I think that we feel we've an opening door to walk through or jump through, run through or whatever you say, that some of our competitors are quite busy right now with either digesting acquisitions or just embarking on them, a couple of our primary competitors. So, we are hoping that that gives us a little bit more of an entry to really take that market. Our intention here is to dominate the web gateway market and that's really what you're going to see focus of this company be for the next year.

Joel Fishbein – Lazard

The second question comes, regarding, Tim, you talked about last quarter – on the last call that about $11 million got pushed from Q1. And even assuming you got half of that in Q1, you would have crushed the number. Why the lower guidance for Q2?

Tim Steinkopf

Yes, we've never had that many deals or that amount of deals slip out of the end of a quarter as we discussed on the 7th. And although there are some results out there that did fine for Q1 and said they were fine for North America, there were certainly other data points where there are concerns about the North America economy, market, macroeconomic environment, et cetera. So, given that we're looking at a phenomenon at the end of Q1 that we've never seen before and the overall macro environment in the Americas especially, we felt it to be prudent to be conservative as we look into Q2.

Joel Fishbein – Lazard

All right. I'll jump back into queue. Thanks.

Operator

Eric Martinuzzi, your line is open with Craig-Hallum.

Eric Martinuzzi – Craig-Hallum

Just curious, given the guidance on the billings for Q2, I think up slightly from Q1 was the way you characterized it. That would imply a decline from a year ago. A year ago we had – I think billings were $70.7 million or so. So up slightly. Is that $69.5 million or is that $71 million? Could we be in a contracting mode here for the foreseeable future?

Tim Steinkopf

I think we would say that we expect to be maybe up slightly from prior year as well. But, again, when you look at the macro environment, we feel it prudent to look hard at the pipeline we've and feel comfortable with what's in that pipeline relative to expectations to close and guide appropriately. And that still means that there's basically two months to go on this quarter. There's a lot of work to get done.

Eric Martinuzzi – Craig-Hallum

One more if I might. One of the things you've done here is you’ve looked at your cost structure. What about your business segments? Is that on the table? Could we see potential strategic diversification here where maybe we aren't in certain businesses in the future that we currently are in?

Tim Steinkopf

I don't think we've any particular plans to announce there, but I would say in looking at our strategy, anything's on the table. We'll do anything that we think maximizes the shareholder value and our growth opportunity and whether that's acquisitions or doing what you suggested.

Eric Martinuzzi – Craig-Hallum

Thank you.

Operator

Bob Owens with Pacific Crest Securities, your line is open.

Bob Owens – Pacific Crest Securities

Yes, good afternoon, everyone.

Dan Ryan

Hi, Rob.

Bob Owens – Pacific Crest Securities

Any type of update you can give us with regard to the lawsuit with Finjan, where you're at in that process?

Tim Steinkopf

Well, the status is the jury has entered a verdict against us. We won on one count on the trial. They won on two counts. There was a verdict entered against us, and we've filed motions relative to that set aside, we were asking the judge to set that aside, reduce the damages, et cetera, et cetera. Of course, Finjan has also filed motions for an injunction. All of the typical motions that both sides would file. We expect the judge to rule on those motions in three to five months, so sometime maybe in Q2, it might slip into July/August. Can't readily predict that. I'm sure whoever comes out on the short end of the judge's ruling will file appeals to the appellate court and that will take one year to two years to play out. So, a lot of game to be played there yet. As we've stated before, we don't believe that's going to be a material item to the company when it eventually does get resolved. But it's probably at least 1.5 years-plus time frame before it's finally all put to rest.

Bob Owens – Pacific Crest Securities

Along those lines, is that causing any disruption in the selling process? Customer adoption team, I guess?

Dan Ryan

It's certainly been distracting to us as a company. I think that obviously Finjan is putting this out in the market in front of a lot of prospective customers and trying to make something from that or of that. I would say that – I'm aware of one substantial deal that we would directly relate to this. We're not aware of any other ones at this time. They may exist, but we're not aware of them, and there was one specific one we know. We should also reinstate [ph] – I'm sure you've heard this before this infringement isn't about the broader Webwasher product line. It's about one element of that product line and we do have the ability to ship the product today without the alleged infringement if we chose to do that. We're obviously not choosing to do that, and we've a long ways to go in the fight. So I think – another thing is we don't really see Finjan competing with us in many deals (inaudible) the Bluecoats and WebCensus we're seeing on the Webwasher side. But I would say it hasn't been a terrible business environment for us because of it. It has been some distraction to it and there is some small business impact.

Tim Steinkopf

It's kind of a nuisance on the side. It's there. We've to deal with it. We don't see them that much, but definitely it is a bit nuisance. You couldn't say it's had zero impact. It's been a nuisance.

Bob Owens – Pacific Crest Securities

Great, thanks.

Operator

Jonathan Ruykhaver with ThinkPanmure, your line is open.

Jonathan Ruykhaver – ThinkPanmure

Good afternoon. It looks like you incurred $2 million in legal expenses related to Finjan. Is that the type of run rate we should expect in terms of cash expense in the next few quarters?

Tim Steinkopf

No – yes you're correct we did incur a fairly significant item in Q1 because of the trial, et cetera. But going forward, probably $300,000 to $400,000 a quarter for a couple quarters or two or three quarters has been built in. That's what we would expect to incur for the balance of the year.

Jonathan Ruykhaver – ThinkPanmure

That's not included in the non-GAAP guidance you gave?

Tim Steinkopf

No, it is included.

Jonathan Ruykhaver – ThinkPanmure

It is. Okay.

Tim Steinkopf

It is included.

Jonathan Ruykhaver – ThinkPanmure

In terms of the $11 million deals that slipped out of March, would you characterize most of those as network security products?

Tim Steinkopf

We looked at that and yes, probably more gateway security then I'm, but in some respects fairly evenly spread out across all four product lines.

Jonathan Ruykhaver – ThinkPanmure

So, you even saw some pushed out of the web security side?

Tim Steinkopf

Yes, and it wasn't necessary to any product line. It really seemed to be more focused by geography because we didn't see the slippage in EMEA in any type of product line nor in Asia Pac, but we saw it in North America and a little bit laps in North America especially, and it seemed to be across all product lines. But at the end of the day, as Dan stated in either one of his questions or prepared remarks, was we still are seeing as far as all of the product lines go, an IDC would probably back this up as well. Our best growth opportunity, and we're seeing it in our activity, is in the web gateway area.

Jonathan Ruykhaver – ThinkPanmure

Right. And I guess just going back to the network gateway marketplace. Is there a contraction that's occurring in that marketplace or is there heightened competition? I'm just trying to get a sense for what is causing the problems in that particular market, because I think most of your gateway business is probably in the firewall marketplace.

Dan Ryan

Well, I don't think – I think we've three gateway products: mail, web, and firewall. I would say, as Tim said, there's some contraction in each. I don't think we're seeing any particular fallback in our network gateway business. We actually had a nice growth in that business over the past year. I think that the – it doesn't have the kind of growth we're seeing in web gateway, but I don't think we've seen a particular fallback there. We focus in – we have a very good position, I don't know if you call it a niche market or a sub-segment of these high assurance network and we do a lot in government and financial services. And there's a lot of initiatives that are supporting whatever downturn there is economically when you have PCI DFF [ph] initiatives and this critical infrastructure initiatives are going on right now. We're in a lot of those deals. I wouldn't say that there was a pretty good fallout in our network gateway any more than any other –

Jonathan Ruykhaver – ThinkPanmure

But I guess, just year-over-year looking at the billings growth being flat year-over-year for the most part and you're saying that the web gateway business is growing and mail is probably doing okay. So, it’d have to be either the authentication or the firewall business that's been showing accelerated growth.

Tim Steinkopf

Yes, maybe another way to think about it is when the markets – we perceive the markets to still be strong, it's just that they seem to be a little bit pressured right now. But we don't perceive it to be in the market. We perceive it more in the macroeconomic environment. So, if the projects are not going away, they're getting pushed out. People are not saying they're not important or they're not going to do it. They're saying I need to get another signature or need to go back through CapEx committee or it's going to take us longer to get it approved. What we're seeing is more of a macro pressure from the environment than a specific segment of the market that's kind of backing up.

Jonathan Ruykhaver – ThinkPanmure

Okay. So, is it safe to assume that based the revenue guidance for June, you're being pretty conservative still as it relates to closure rates, sales cycles, continue to deteriorate?

Dan Ryan

Yes, that would be the way to think about it.

Jonathan Ruykhaver – ThinkPanmure

All right, guys. Thanks.

Operator

Fred Ziegel with Soleil Securities, your line is open.

Fred Ziegel – Soleil Securities

Hi, everybody.

Dan Ryan

Hey, Fred.

Fred Ziegel – Soleil Securities

Let me ask a couple of things. First, on the bigger deals, I would presume they are generally multi-product in terms of people looking at doing a couple of different things?

Dan Ryan

Probably more often they're not, actually, Fred. I would say many of the big deals tend to be single product, kind of enterprise rollout or enterprise deployment. We do have multi-product deals all the time, but I wouldn't characterize – if you went through our biggest deals, I would say, they're more likely to be one product than they are to be three.

Fred Ziegel – Soleil Securities

Okay.

Tim Steinkopf

Yes, I agree and what that actually provides us is the opportunity to back and cross-sell which we're definitely seeing an uptick in.

Fred Ziegel – Soleil Securities

But if we're going to defocus some areas of the business, does that opportunity go away?

Tim Steinkopf

No, because what – I think maybe – paraphrase Dan's comments, it is focus in on the areas where each product is the strongest. So, web and mail happen to be strong in broad areas and we can look to be market leaders there in broad areas. Whereas secure firewall, secure IM, they are potentially a little bit more focused or have the opportunity to be leaders in a little bit more focused area. And that's where we will have the most success cross-selling also. So, it's really focusing in where we're the strongest.

Dan Ryan

If we've an account that's a big Webwasher account and they're looking for firewalls, we're not going to tell the salesperson not to introduce Sidewinder to the account because it's not in one of the key verticals. In reality, we'll have more cross-selling in the key two or three verticals for firewall than we would in the general world.

Fred Ziegel – Soleil Securities

The 75 person headcount reduction – how is that spread out across the various disciplines?

Tim Steinkopf

We tried very hard to impact sales generation the least amount as possible, and we tried also to impact our development team probably second least amount possible. So, what I'll call the service organizations within the company, legal, HR, marketing – we tried also to limit the impact to marketing. That probably was third in line. But then the service organizations, the balance of marketing, legal, HR, finance, operations, IT, et cetera – those groups really stepped up and said, “Okay, we're going to try to cut our costs as aggressively as possible,” because we want to maintain our investment in innovation and the road maps we're on and want to maintain the lead generation pipeline generation machine.

Dan Ryan

Hopefully, it's clear also from the discussion that we not only took that money out of the company that Tim described, we added specifically a substantial amount of money back to the web gateway development and go-to-market areas. So, that's all built into the numbers that we gave you. So, the actual cut was probably more substantial when you consider that add back.

Fred Ziegel – Soleil Securities

Okay. All right, thanks.

Operator

Josh Jabs with Roth Capital, your line is open.

Josh Jabs – Roth Capital

Good afternoon.

Dan Ryan

Hey, Josh.

Josh Jabs – Roth Capital

On the previous call, you talked about the government sector, the Federal sector, and some of the issues that you had seen in Q1. How is that looking now for Q2 and Q3?

Dan Ryan

I would say we're cautiously optimistic about the U.S. federal government pipeline right now. So, obviously we're fool once or fool me once, right? So, we are being cautious, but I think we're seeing a strong opportunity there, a good comeback.

Josh Jabs – Roth Capital

And then, going back to this product diversification or consolidation or however this plays out. You mentioned the area of focus. At the same time, it seems like the market has been looking for more consolidated offerings. Specifically, how do you pull back in one area such as UTM, but continue to invest the others and does that mean more of a downmarket shift with the services offerings?

Dan Ryan

I think when you talk about the combination, the natural synergy is between web and mail. First of all, there's a much more natural synergy in selling those products together. And that is a consolidated offering. If you look at what we're doing, we're trying to come up with a set of services, web and mail-based services, that we don't care which ones you pick and how you want it delivered, whether it's in a box or in the cloud [ph]. That is very synergistic, more so than with the firewall, with the firewall business I think. So, I would say we're not trying to necessarily narrow our product breadth; however, we do want to be known for something and secure computing in the broader sense really hasn't been known for something. And our objective here is we want to take leadership in a market that'll accelerate our channel, that will accelerate our customer acquisition, and that we can bring all of our other products into it as well.

Tim Steinkopf

I would submit to you, Josh, I think we're potentially a step or two or three ahead of our competitors in consolidation. We already consolidate at the web gateway services such as SSL, antimalware, antivirus, web filtering, et cetera. We have the same type of consolidated services at the mail gateway with DLP encryption, AV, TrustedSource reputation. We have TrustedSource reputation-based technology at the web as well. And look at our set of services at the enterprise gateway. So, I think Secure has actually been a leader in consolidating services at appropriate areas or appropriate spots in the network. Now, what we're saying is we're going to take those spots and really focus in on trying to capitalize on our leadership there.

Dan Ryan

One more example – Tim brought up some good ones – the mail and web gateway, there's a lot of discussions in the market today about daily prevention or protection DLP. A lot of pure play companies that we partner with on a regular basis in our web gateway solution. With these services we have between web and mail, the vast majority of the DLP problem [ph] is in motion through those protocols, web and mail. One of the things we want to do is, first, provide DLP services with common policy across them. And again, we are going to continue consolidate (inaudible). We're not trying to replace Vontu or anybody on desktop-type applications, but the 80/20 rule is if you can stop the majority of it there, that's another great service that we can consolidate.

Josh Jabs – Roth Capital

Moving to the service – on the services side. Is that kind of put you in competition with any of your service provider customers?

Dan Ryan

Nothing we are aware of. We have some MSP partners that provide services. In fact, we would see an opportunity to actually license our services through other partners that could actually sell those services. I mean we have no issue private labeling some of these hosted security services, if that makes sense.

Josh Jabs – Roth Capital

And then specifically on the OEM side with some of your services. I know you've expanded that quite a bit here this spring, but can you just give us some color on how that's going?

Dan Ryan

Could you repeat that?

Josh Jabs – Roth Capital

The OEM with the partnerships specifically for TrustedSource?

Dan Ryan

We continue to go down that path. I think we have several partnerships. I would say that our most active partnerships today are less around TrustedSource and more around virtualization and also working with Riverbed in some joint solutions. I think that the TrustedSource alliance that we have had out there – we continue to market that and to sell that and we're active there. I don't think that's a big revenue opportunity for us in the near term.

Josh Jabs – Roth Capital

Okay.

Tim Steinkopf

I think in a broad sense, we believe that – and I think that quite a bit of the market or IT pundits would agree that eventually reputation-based technology is going to be a clear driver or gating factor for activity on the web, and TrustedSource is a leader there still. It's best for us to continue the broad capture of data such that we can maintain TrustedSource as the true leader in that reputation based arena.

Dan Ryan

That's another good point where we see synergy and consolidation between web and mail. We have TrustedSource reputation information now includes web reputation, malware, again mail reputation as we always have. And as we get into the cloud and all of a sudden have thousands more points of reference and data collection, because of our customers are going through the service. We just get that much more visibility on the data that's out there that we can correlate.

Josh Jabs – Roth Capital

Okay. Last question. A little bit of the shift in focus here, and the cost reductions cause a change in the comp structure that you recently introduced for your sales team?

Dan Ryan

No, it will not. The comp structure with the emphasis on new business development and cross-selling remains intact.

Josh Jabs – Roth Capital

Okay. Great, thanks.

Dan Ryan

It's definitely having an impact.

Operator

Sarah Friar with Goldman Sachs, your line is open.

Fred Green – Goldman Sachs

Hey, this is Fred Green [ph] for Sarah. You're taking a pause in paying down your debt right now. How long do you expect before you resume paying it down? And is there a certain amount of cash you're looking to keep on your books going forward?

Tim Steinkopf

Yes, we've taken a pause, Fred, and the big reason we took a pause is because of the macroeconomic environment. And again, we just saw this macro environment and said maybe it would be better to put that cash on the balance sheet. I think – although we have not determined an exact level of what we want on a balance sheet before we start paying again, I think somewhere probably between $25 million and $50 million. And that will be a discussion we have with the board on an ongoing basis. And then I think once we build it up to a certain level, we'll consider paying down more or maybe we'll build it up to a certain point where we can pay down some big chunks at certain time levels. But for the near future, we're going to be putting the money on the balance sheet for now.

Fred Green – Goldman Sachs

Okay. Great, and do you have an update on sort of how long you think it will be until you have a workaround for the Finjan patents?

Dan Ryan

I don't know that – I'm not going to talk about a workaround. We have the ability immediately to ship a product without the piece of the product that is alleged to infringe. We don't agree it infringes, but if we were caused to, we could ship a product without that. It's one type of detection mechanism among many on the product, and we can ship without that.

Fred Green – Goldman Sachs

Okay. Thanks a lot.

Operator

Joe Maxa with Dougherty & Company, your line is open.

Joe Maxa – Dougherty & Co.

Thanks. Regarding your SafeWord and your narrowing your focus to the remote access solutions, does this mean you're effectively taking yourselves out of the larger consumer authentication opportunities?

Dan Ryan

I think that when we say focused, we have some of the largest deployments in the world too. So it's a little bit of a dichotomy. But with SafeWord 2008 and really the successful no touch channel we've built around SafeWord and Microsoft deployments. We're going to continue to put a lot of the focus there. That's what is growing well for us. That's what has the best channel progress right now and that's the one that we think we have some uniqueness. I mean our product rolls out in that environment very easily, much more readily than most products, and this is where the marketing focus would be, I'd say. I guess we'll still continue to sell into accounts we're in. But this is where we see a nice, steady predictable growth through a relatively low-touch channel.

Joe Maxa – Dougherty & Co.

Are you seeing any changes in the market that might keep you from more aggressively going after the hardware token side?

Dan Ryan

We do the mobile pass-type electronic token which of course everybody's anticipated would be replacing tokens and that has not come to fruition. We still have a vast majority of the business goes with physical tokens, and we haven't seen a substantial change there in our business, at least right now. We keep anticipating that we'll move to other forums. We're very aware of that, but it hasn't happened yet.

Tim Steinkopf

And I think that – what Dan just said is maybe the key item to both questions you asked, Joe, and as much as we continue to look for consumer opportunities, or et cetera, the token market is not evolving that quickly. It seems like remote access tokens is still the leading solution and the market has not really embraced the next step or the next direction. So, what we want to do currently is try and capitalize on that and make the most of that. In the meantime, we will certainly be paying attention to where does that next path really show up, so that we can then jump into that. At present, tokens, remote access, business enterprise, is still the leading drivers in that part of the market.

Joe Maxa – Dougherty & Co.

Great, thanks a lot, guys.

Operator

Katherine Egbert with Jefferies, your line is open.

Katherine Egbert – Jefferies & Co.

Hi, I think before you answered the question about what positions you cut and you said it was mainly services. What planned positions did you eliminate?

Tim Steinkopf

I'm sorry, Katherine, you must be on a mobile. You're cracking up a little bit. So, we did eliminate services and you said what?

Katherine Egbert – Jefferies & Co.

What planned positions?

Tim Steinkopf

Oh, planned positions. Planned positions was a little bit more across the board. We're not seeing quite the level of growth that we've been planning on, and the plan, of course, had been kind of not – it's not a perfect peanut butter spread across the whole organization, but it was spread across the organization. So, the planned position was a little bit more evenly spread across the board.

Katherine Egbert – Jefferies & Co.

Okay, thanks.

Operator

Eric Suppiger with Signal Hill, your line is open.

Eric Suppiger – Signal Hill

Good afternoon.

Tim Steinkopf

Hey, Eric.

Eric Suppiger – Signal Hill

Did you give the headcount earlier?

Tim Steinkopf

No, but I think post the actions we've took this week, we should be right around 900.

Eric Suppiger – Signal Hill

And I presume at the end of the quarter it was 975? So all of the cuts have been done at this point?

Tim Steinkopf

Yes, substantially, yes.

Eric Suppiger – Signal Hill

Okay. Can you give us a little feel – I guess I'm trying to understand what parts of the firewall market you're going to be redirecting your focus away from?

Dan Ryan

Well, I think I would say we don't feel that we're probably a strong competitor in the general network firewall space horizontally, right. That's not our strength. We're much more specialized in high-value data, high-value applications. And in fact many cases our firewalls are used behind other perimeter firewalls. So, I think what we're saying is our development effort is going to be to double down where we win today. And we do a fantastic job in federal government, in financial services, in utilities, in other areas where we're protecting high value applications and data, and I think it's easy for us to find ourselves competing with network firewalls. It's easy to get drawn into those fights against the big firewall players. And I think we want to pick the fights where we can win and really go aggressively after those instead. We don't want to find ourselves in every network deal where we have a one in ten chance to win. We want to be in the deals where they're high value and high margin and we have a layer 7 orientation, an application layer orientation where we have a 3 out of 4 chance of winning, not a 3 out of 4 chance of losing.

Tim Steinkopf

To add on just briefly, we're going to compete with the same people, if it's a layer 3 or 4 deal. If it's a perimeter network deal, as we compete with when it's a layer 7 deal. When it's in front of an Oracle Server or application et cetera. We're certainly going to compete. But we have a much better chance to win when it's a layer 7 oriented-type of project and that's where we really want to make sure. You get into those high assurance networks. That's where we're going to get a higher win ratio. So, we're going to make sure we're really focusing in and competing in as many of those as possible.

Dan Ryan

The other thing we mentioned briefly that we're just embarking on, we announced this week some activities we're doing in virtualization. Our product is a software product, effectively running on a hardened black box, but this is very easily virtualized. We don't have a lot of semiconductor dependencies. So, we have some unique capability where people need virtual firewall capabilities that many of the other competitors do not have that depend on silicon and proprietary platforms.

Eric Suppiger – Signal Hill

Okay, and then can you help us a little bit in terms of measuring how your stronger-performing products are performing? And specifically, I'm talking about the web gateway and the mail security products. You're not breaking them out, so can you give us some way of gauging how your success in those areas is performing since that's arguably where the greatest investor interest would lie?

Dan Ryan

Still we're not breaking them out now. We may choose to do that, however, in the future so there would be more clarity on that. I would just say what I did mention, is that Gartner has said the market rate is growing for web – is the least penetrated at 15% with growth rates depending on whether it's appliance or wholesale somewhere between 20% and 35%, 36%. And I think that our recent history for Webwasher has been in excess of those growth rates. I would say mail is almost inextricably – it can't be removed from web. I think it's becoming part of web, particularly related to the web 2.0 protection opportunity with our SWAT program. Really, mail and web are a hybrid solution now, and we're seeing those will emerging more and more together in our eyes with our solutions. We'll probably talk about these together. We probably won't even separate. If we do more segmentation, it probably won't be to separate web from mail. It might be to separate web and mail from network and access.

Eric Suppiger – Signal Hill

As a sales strategy, are you moving away from bundling the firewall with either the web or the mail and just selling them on a bundled basis more often?

Dan Ryan

We still sell the firewall as the right solution to put in front of our other gateways. Obviously, we try and put as many of our products in as possible, but I think that – that's a different procurement I think in many cases. So, there's just more synergy with web and mail and I think from a cloud perspective, having a hosted offering, having the flexibility of having remote offices or home or internet cafe users going through the cloud and people at corporate going through the appliance. We see a more of a natural synergy between mail and web services.

Eric Suppiger – Signal Hill

Okay. Last one, is there much cost associated with the infrastructure for the hosted service?

Tim Steinkopf

Yes, there's cost, of course, in rolling it out. And hopefully there's going to be a lot of costs because it will be so successful that we'll need a lot of capital and pipes going in. But we do have, I believe seven data centers around the world today that support our TrustedSource environment, so we're quite familiar with this. It's not like we're a startup diving into this for the first time. So, it really is layering on hardware and software infrastructure in those data centers and in some cases increasing the pipestone [ph].

Dan Ryan

We've got that in our plan. I mean that's in the budget that we described to you.

Eric Suppiger – Signal Hill

Very good. Thank you.

Operator

Thank you, our last question comes from Todd Raker with Deutsche Bank. Your line is open.

Todd Raker – Deutsche Bank

Hey, guys, two questions for you, can you hear me?

Dan Ryan

Yes.

Todd Raker – Deutsche Bank

First, just looking at the balance sheet, it look like long-term deferred revenue kind of came down as a percentage here. Are you seeing shorter duration bookings and if so what's driving the economy?

Tim Steinkopf

Actually yes to both. Yes, we did see a reduction in the longer term. And yes, when it was specifically cited as to why that would happen, the economy, budget dollars, cash flow was the most often-cited reason.

Todd Raker – Deutsche Bank

And if I step back, you guys are clearly cautious with the outlook given the experience you had, but if I look more generally across the security space, here the results by and large have been relatively robust. And it doesn't look like some of the larger companies in this space are seeing the same type of macro headwinds that you guys are.

Tim Steinkopf

Well, what I would say is that there are certainly a few companies that have had some troubles, along with us. I would agree with you that there's been some that have not. The interesting thing for us is that if our government business had not run into troubles via the budgeting, et cetera, we would have hit our numbers. And therefore, we would have put up potentially exceeds numbers, maybe a little short on billings, but the rest of the numbers, revenue and earnings, et cetera, cash flow, would have all been at the high end, if not maybe even exceeded guidance. And it's interesting, in analyzing that situation, there's some people – I'm not saying we're predicting this, but in analyzing the situation looking forward, there's at least some level of concern that the Q2 will be when the commercial markets really come home to roost. And I think you've seen that in the more conservative guidance headed into Q2. So some companies have made their Q1 numbers. They've got it conservatively for Q2. We would have been in that same boat if we hadn't had the double whammy of government as well. I think for us we're very much – we're somewhat concentrating on government. We will also have that concentration in finance and banking, which of course they're suffering from some macro factors as well. That would be our view of it.

Todd Raker – Deutsche Bank

All right, thanks, guys, appreciate it.

Operator

I'll now turn the call back over to Dan Ryan.

Dan Ryan

Well, thank you for joining us and thanks for taking the time to ask the questions. Hopefully we answered them and look forward to updating you on our progress in three months. We remain optimistic on our business and hopefully we'll have something good to report in three months.

Operator

Thank you. This does conclude today's conference call. You may disconnect at this time.

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