Blue Coat Systems, Inc. F4Q08 (Qtr End 4/30/08) Earnings Call Transcript

Blue Coat Systems, Inc. (BCSI)

F4Q08 Earnings Call

May 22, 2008 8:00 am ET

Executives

Daniel Levy

Kevin S. Royal – Chief Financial Officer & Senior Vice President

Brian M. NeSmith – President, Chief Executive Officer & Director

Analysts

Samuel Wilson - JMP Securities

Ryan Hutchinson - Lazard Capital Markets

Erik Suppiger - Signal Hill Group LLC

Scott Zeller - Needham & Company

Joshua Jabs - Roth Capital Partners LLC

Rohit Chopra - Wedbush Morgan Securities, Inc.

Rajesh Ghai - ThinkPanmure LLC

Alex Kurtz - Merriman Curhan Ford & Co.

Gabriel Lowy - Collins Stewart LLC

Rob Owens - Pacific Crest Securities

Presentation

Operator

Ladies and Gentlemen, thank you for standing by and welcome to the Blue Coat Systems Q4 and full 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 given at that time. (Operator Instructions) As a reminder, today's call is being recorded. At this time then I'd like to turn the conference over to Mr. Dan Levy.

Daniel Levy

Good morning and thank you for joining us today. Kevin Royal, Senior Vice President & Chief Financial Officer, will begin today's call with an overview of financial results for the fourth quarter of fiscal year 2008 ended April 30, 2008 and the financial outlook for the Company. Brian NeSmith, Blue Coat's President & Chief Executive Officer, will then follow with his commentary and other operating highlights.

The information presented in today's conference call is for informational purposes only and is not an offer to buy or the solicitation of an offer to sell any securities. The solicitation and offer to buy shares of Packeteer common stock will only be made pursuant to the offer to purchase any related materials of Blue Coat Systems, Inc. and Cooper Acquisition, Inc. filed with the Securities & Exchange Commission on May 1, 2008, as amended from time to time. Packeteer stockholders should read these documents carefully prior to making any decisions with respect to the offer because they contain important information including the terms and conditions of the offer. Packeteer stockholders may obtain the offer to purchase and related materials with respect to the offer free of charge at the SEC's web site at www.SEC.gov from the information agent named in the tendered offer materials or from Blue Coat Systems, Inc.

As you know, we will make forward-looking statements during the course of this call about Blue Coat Systems, Inc. and Packeteer, Inc. These include statements regarding expectations concerning market growth and business opportunities, expectations regarding future revenues, expenses, margins, tax rates, and other financial metrics, and other matters impacting Blue Coat's financial outlook and future business, as well as that of the potential combined entity. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including the expected timing of the completion of the acquisition of Packeteer, the ability to complete the transaction considering the various closing conditions, and any statements of expectation or belief and any statements of assumptions underlying any of the foregoing.

Risks, uncertainties and assumptions include the possibility that expected benefits may not materialize as expected. Risks related to the timing or ultimate completion of the transaction that prior to the completion of the transaction the parties' respective businesses may not perform as expected due to uncertainty, that the parties are unable to successfully implement integration strategies, and other risks that are described from time to time in the Securities & Exchange Commission's reports filed by Blue Coat, including but not limited to the risks described in Blue Coat's annual report on Form 10K for the year ended April 30, 2007 and quarterly report on Form 10Q for the quarter ended January 31, 2008. Accordingly, no assurances can be given that any of the events anticipated by the forward-looking statements will transpire or occur or if any of them do so, what impact they will have on the results of operations or the financial condition of Blue Coat or Packeteer. Blue Coat assumes no obligation and does not intend to update these forward-looking statements except as required by applicable law.

Now I'll turn the call over to Kevin.

Kevin S. Royal

Today we're pleased to announce another quarter of record net revenue of $88.2 million for the fourth fiscal quarter of 2008, an 8% increase compared to net revenue of $81.4 million reported in the prior quarter. Included in the $88.2 million of net revenue is product revenue of $66.2 million which includes sales of appliances in Blue Coat WebFilter. Product revenue in the fourth quarter of fiscal 2008 reflects a 5% increase compared to $62.8 million in the prior quarter. Total Blue Coat WebFilter revenue decreased 11% to $8.8 million in the fourth fiscal quarter compared to $9.8 million in the third quarter. Approximately $7.1 million of the revenue recognized on Blue Coat WebFilter this quarter is related to perpetual licenses compared to $7.9 million in the third quarter of fiscal 2008.

Now turning to service revenue, we recognized $22 million in the fourth quarter a 19% increase over $18.5 million recognized in the prior quarter which was driven primarily by the continued growth in our installed base over the last several quarters. On a geographic basis net revenue in North America was $36 million representing approximately 41% of total revenue. Net revenue in EMEA and Latin America was $35.2 million representing approximately 40% of total revenue and net revenue in the Asia Pacific region was $17 million representing approximately 19% of total revenue.

Gross margin on a non-GAAP basis decreased to 76.8% in the third fiscal quarter from 77.1% in the prior quarter. The decrease in gross margin is due to geographic mix. On a non-GAAP basis operating expenses increased approximately $6 million to $54.2 million in the fourth quarter. As a percentage of total net revenue operating expenses increased approximately 2%. Non-GAAP R&D expense increased approximately $800,000 from the prior quarter but was essentially flat as a percentage of revenue. We intend to continue to invest in R&D therefore, we expect R&D spending to continue to increase in absolute dollars. Non-GAAP sales and marketing expense increased approximately $3.9 million and increased approximately 1% as a percentage of net revenue over the prior quarter. The increase in non-GAAP sales and marketing expense primarily results from increased head count to expand our sales force and marketing function. Our number of sales teams increased from 92 at the end of the third quarter to 99 teams at the end of the fourth quarter.

Non-GAAP G&A expense in the fourth quarter increased approximately $1.2 million from the prior quarter and increased approximately 1% as a percentage of net revenue. The increase in non-GAAP G&A expense was largely attributable to higher legal and accounting fees in connection with our year-end audit and tax planning activities. On a non-GAAP basis the Company reported net income of $13.1 million or $0.33 per diluted share in the fourth fiscal quarter of 2008 compared to non-GAAP net income of $15.3 million or $0.38 per diluted share in the prior quarter. For purposes of calculating non-GAAP earnings per share for the quarter ended April 30, 2008 our fully diluted shares were approximately 39.6 million. On a GAAP basis the Company reported net income of $12.5 million or $0.32 per diluted share in the fourth fiscal quarter of 2008 compared to net income of $10.5 million or $0.26 per diluted share in the prior quarter. As a reminder, a reconciliation of non-GAAP to GAAP financial measures is included in today's press release.

Now I'd like to provide some clarification related to our tax provision on a GAAP and non-GAAP basis. On a GAAP basis we recognized a net tax benefit of $3.6 million related to the partial reversal of our valuation allowance on deferred tax assets partially offset by a tax charge associated with the implementation of our new global business structure. For purposes of presenting non-GAAP net income in a manner consistent with prior periods, we excluded the reversal of valuation allowance and tax charge associated with the implementation of our new global business structure and calculated a non-GAAP provision for income taxes of $1.5 million. The non-GAAP provision for income taxes was approximately $800,000 higher than originally estimated as a result of changes in estimates of certain service revenue used in determining profit on a tax basis.

Turning to the balance sheet, we ended the quarter with cash, restricted cash and investments of approximately $188.1 million representing an increase of $20.1 million from the prior quarter. Non-GAAP operating cash flow in the fourth fiscal quarter was $22 million compared to $17 million in the prior quarter. Capital expenditures were $4.6 million for the fourth fiscal quarter and depreciation and amortization was $2 million. In addition the net proceeds from the issuance of common stock as a result of the exercise of stock options totaled approximately $3 million. Our accounts receivable balance increased by $10.5 million during the quarter due to the increase in revenue and DSOs which increased to 60 days at the end of our fourth fiscal quarter due to the regional shift in revenues.

We currently anticipate our announced acquisition of Packeteer to close in our first quarter of fiscal 2009 ending July 31, 2008 and that we will be operating as a combined entity before the quarter ends. However, because it is not certain when and if the transaction will close, it is not possible for us to provide earnings guidance for this quarter. For our first quarter of fiscal 2009 the Company currently anticipates net revenue and spending levels excluding the results of operations of Packeteer to be approximately equal to fiscal Q4 2008 levels. Further, we anticipate that the acquisition of Packeteer will be accretive to our earnings in our third quarter of fiscal 2009. In addition, we are targeting operating profit as a percentage of revenue of the combined companies in the range of 17% to 18% in our fourth quarter of fiscal 2009.

As you are aware, we announced on April 21 that the Company entered into a definitive agreement to acquire Packeteer for $7.10 per share. This acquisition will be effected through a tender offer for all the outstanding shares of Packeteer followed by a merger into a subsidiary of the company. The tender offer commenced on May 1, 2008 and unless extended will expire on May 30, 2008. We recently announced the expiration of the HSR waiting period. The transaction is subject to customary conditions and is expected to close in the first quarter of fiscal 2009. We will be able to provide you with our expectations regarding the combined operations following the close.

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

Brian M. NeSmith

Good morning and thank you for joining us. The results for this quarter were mixed. We continue to see a good response to our ProxySG product from both acceleration and security as demonstrated by these financial results and continued customer growth despite challenging business and economic conditions. As we entered this quarter our pipeline forecast led us to believe that we would achieve the higher end of our forecast. However, as the quarter unfolded, the business environment in North America degraded especially with respect to larger deals. We recognized the challenge and actively worked to compensate for a possible US shortfall by growing our business in Europe, the Middle East and Asia. We had some success with the expanded international focus but the environment in the US continued to degrade throughout the quarter. In the end we could not fully compensate for the US shortfall despite growing our business internationally.

One of the surprising characteristics of this quarter in light of our overall results was the continued overall growth of the opportunity pipeline in both the US and overall. We continue to see healthy growth in that pipeline. What changed was the closure rate, especially in larger deals. We had several deals that were already approved at the highest levels up to and including the CFO. By any historical view of that pipeline we would have expected most of these deals to close last quarter. However the news of the Bear Stearns collapse in mid-March created a chilling effect, not only in financial services but broadly across almost all sectors in the US economy except for energy and government. Many of the larger deals already approved were held up and would require re-approval which in many cases would not be given in the near term. This behavior continued throughout the remainder of the quarter. Not all large deals were held up. We did close over five deals each valued at more than $1 million, and we saw a good number of deals between $100,000 and $500,000 in value. Part of what we've done for this quarter is to analyze the large deals more closely and in many cases have changed our forecasted close rate on these larger deals to a much lower rate. To be clear, the vast majority of these deals are not losses; they are delays.

On the positive front we see a lot of opportunity internationally and changed our current sales investment to emphasize growth outside of the US. We anticipate that the bulk of our growth this coming fiscal year will predominantly be outside of the United States and broadly speaking in the government sector. We have been aggressively investing in Asia and the Middle East over the past year and we look to accelerate that trend given the opportunity and pipeline we see in those geographies. In addition, we see lots of opportunities in the carrier environment including managed services, concept filtering, network acceleration, and security services. That said, we do not expect business in the US to grow significantly for several quarters. In some of our markets we'll be changing the emphasis of how we market our value proposition. Companies can deploy our ProxySG appliances to achieve security and control and at the same time get immediate savings in operational costs. We can actually reduce Internet bandwidth consumption by as much as 50%. This means that customers can recoup their investment in relatively short order and transform a capital purchase into pure operational savings.

It's very clear that we're not immune to this challenging economic environment but we do see opportunities by emphasizing a different part of our value proposition and focusing on sales opportunities where return on investment is the justification for purchase. The net of the macroeconomic environment is that the US is challenging but there continue to be opportunities in this environment with specific customers and segments as well as through emphasizing a change of value proposition. We do expect that our growth this year to be more heavily weighted to the international geographies.

As you know, last month we announced our intention to acquire Packeteer a pioneer in application and identification and traffic shaping technologies. Earlier this week we passed an important regulatory hurdle, the expiration of the mandatory waiting period under HSR. The tender offer we launched earlier this month we expect to conclude on May 30, 2008 unless we take steps to extend that. Our intended acquisition of Packeteer brings us important short-term and long-term benefits. Upon completion we can utilize the Packeteer sales force to expand our existing sales force by as much as 50%. We will also gain access to the Packeteer channel which has proven expertise in selling network infrastructure solutions. In addition, we will continue to offer Packeteer's well-regarded PacketShaper product. More important we expect to enhance the capability of PacketShaper with new features and capabilities and broaden its utility to both enterprise and carriers. In the near term we expect our PacketShaper revenue to be very similar to that of Packeteers. The potential acquisition also helps us further our long-term vision and strategy for both the WAN optimization market and the secure web gateway market. Packeteer technologies offer an advanced ability to identify or understand specific business applications and a more advanced ability to manage bandwidth and shape traffic across the WAN. The ability to identify applications offers additional strength to our security capabilities because if you can't see unwanted or malicious applications you can't stop them. Application identification is also critical for optimizing the WAN as it enables prioritization of mission critical applications over that of other applications to ensure delivery of essential information with integrity. We believe we will provide more value to our customers, we respect that both their security requirements and their WAN optimization needs as we integrate Packeteer technologies into our ProxySG.

We also continue to develop our secure web gateway technologies. This past quarter we unveiled our web pulse service for dynamic web analysis. Posted at Blue Coat data centers around the world, this in-the-cloud service enables our Blue Coat WebFilter and associated products to dynamically rate new or unfamiliar web sites and URLs. We recently announced that our web pulse infrastructure now receives over 100 million requests per day including those from K9 Web Protection, our free product for protecting home computers and the families and individuals that use them. These requests enable us to search for new sources of potentially dangerous malicious threats on the Internet. We add this knowledge to our products to continually increase their effectiveness in fighting the ever-increasing dangers of malware.

This past quarter we also announced our technology integration partners program. While this has been our practice and philosophy since our early days, we are renewing and expanding our commitment to give customers best of breed choice for products and technologies to extend the capabilities of our products. This program leverages relationships with technology companies to facilitate inter-operability between Blue Coat products and other solutions giving customers expanded choice for comprehensive secure web gateway and WAN optimization deployments. There are now over 30 vendors in the program representing such categories as enterprise application software, data loss prevention, corporate video, authentication, anti-malware, anti-virus, content filtering, and more. The newest member, Vericept Corporation, adds another strong option for integrated data loss prevention or DLP solutions to protect intellectual property and valuable sensitive data.

Finally, I want to welcome our newest board member, Jim Tolonen. Jim has been elected to fill a newly created seat on the company's board making a sixth board member and fifth independent director of our company. Jim currently serves as the Chief Financial Officer & Senior Vice President of Finance & Administration of Business Objects a company recently acquired by SAP. Before joining Business Objects Mr. Tolonen served as the Chief Financial Officer & Chief Operating Officer of IGN Entertainment and as Chief Financial Officer & Member of the Office of the President at Novell, Inc.

I would now like to turn the call back over to Dan.

Dan Levy

That concludes our prepared remarks. We will not turn the call over to the Operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Samuel Wilson – JMP Securities.

Samuel Wilson - JMP Securities

Just a few small questions, first for Kevin actually, can you give me a sense of what non-GAAP gross margins were for products and services?

Kevin S. Royal

For product separately from services?

Samuel Wilson - JMP Securities

Yes, I'm just trying to figure it out because normally in the last couple of calls you've given us a breakdown of non-GAAP gross margins for products and services?

Kevin S. Royal

Sure. Products were about 79% and services were approximately 69%.

Samuel Wilson - JMP Securities

Second, you mentioned non-GAAP cash flow of $22 million. Is there a difference between GAAP and non-GAAP cash flow for the quarter?

Kevin S. Royal

Yes, there's a tax benefit from the exercise of stock options that you put in for GAAP purposes that's really not a cash flow item so we break that out for purposes of understanding our cash generated from operations.

Samuel Wilson - JMP Securities

Now the fun questions for Brian, it sounds like linearity throughout the quarter was sort of backend loaded as you reacted to the slowdown in North America. Is that a fair assessment? And second, on North America in general it sounds like from your commentary, and I just wanted some color on this, these are not deals that you lost to competition necessarily; these were organizations that just hit the pause button on spending. Is that a fair assessment? And has the market environment gotten more competitive as the quarter rolled through?

Brian M. NeSmith

I expected quite a few questions. Yes, I think it's fair to state that for this quarter we definitely saw the quarter more backend loaded. I think the month of March for us - the overall macroeconomic condition, but what was surprising to me I think is just the reaction that we saw from a lot of customers as people saw the Bear Stearns situation unfold. So March ended up, things slowed down quite substantively and then April for us is probably our biggest month for us in our history which does point to our backend loaded than it has been historically. The other question was linearity, the second question I forgot now which was?

Samuel Wilson - JMP Securities

These were deals that were just the customer hitting the pause button, they weren't deals that were lost to competition?

Brian M. NeSmith

Yes. To answer the question broadly, we didn't see a substantive change in the competitive environment which is what I think you might be getting to in one dimension. And I think the vast majority of what we saw is really delays. I'm not saying that they're like a two-week delays, in some cases it may be longer than that, but it's not losses they're delays.

Operator

Your next question comes from Ryan Hutchinson - Lazard Capital Markets.

Ryan Hutchinson - Lazard Capital Markets

I guess to follow up with Sam's question, just on the geographical breakdown. Is it fair to assume that North America, from your prepared remarks it sounds like North America was the primary culprit and that basically accounted for a few million dollars below your internal forecast, is that fair?

Brian M. NeSmith

Yes, I think it's probably even a bit more than that as we saw the situation deteriorate in North America in the month of March we put a lot of energy into driving the revenue internationally, so I think that we were able to compensate for some of that shortfall in North America but not all of it. We made up some of that but I think that the slowdown we saw in North America is a bit more severe than we thought overall even as reflected in our financial results and I think as we look forward to the future that's a little bit reflective of what we were trying to highlight in some sense of the way we saw next year that our growth is going to be a lot more heavily weighted to the international environment than it is to North America.

Ryan Hutchinson - Lazard Capital Markets

So it's fair to assume that you're not necessarily seeing an uptake in demand here in the first few weeks of May in North America?

Brian M. NeSmith

No, we haven't seen a change in the environment from April to May if that's what you mean.

Ryan Hutchinson - Lazard Capital Markets

And then, did the announcement of the Packeteer acquisition have any impact on your ability to close some deals late in the quarter in terms of maybe channel confusion or anything of that nature?

Brian M. NeSmith

I can't quantify that. I expect there's probably a little bit of that. Clearly the acquisition of Packeteer was a distraction for a lot of people here as an organization the last month of the quarter and that created a bit of a challenge where both a shift from our business focus from North America to international and we're doing that there's obviously a lot of Packeteer pre-announcement discussion and activity. There's clearly some distraction effect. I think there was a little bit in the channel but I'd be really hard-pressed to really figure out how I could quantify that in any way.

Ryan Hutchinson - Lazard Capital Markets

And then two quick ones for Kevin, first of all, just on op ex, it certainly from our estimates came in about $3 million to $3.5 million higher than what we were estimating I think where the street was, so can you just help us understand as you moved from the beginning of the quarter to the end, how that played out? Were there some front-end investments that you couldn't really scale back and demand started to weaken in the back half of the quarter or what really took place there?

Kevin S. Royal

I think operating expense came in a little bit higher than what we had planned, I don't think $3 million. There was higher op ex certainly, about $1 million, and then our tax expense came in significantly higher than what we had planned, roughly $800,000.

Ryan Hutchinson - Lazard Capital Markets

And finally, I'm not certain if you can go here, but just trying to get a general sense, you provided a little bit of color in terms of the guidance in the stand-alone business as well as some combined colors to look out into the fiscal fourth quarter as it relates to the impact to operating margins. I'm just trying to get a sense of the cost synergies here and maybe you could just help us understand that. I'm assuming you're writing down the services revenue due to purchase accounting to zero but in terms of a steady state run rate, Brian sort of highlighted in the prepared remarks thinking about PacketShaper at the levels they were historically at, so if you back out that services component and the rest of the products, [tacet], etc., is it fair to assume that that revenue run rate over the next call it several quarters will build back up towards the $25 million to $30 million level?

Brian M. NeSmith

Yes, I think that's a fair assessment but I think you need to the fact that it's going to happen over a couple of quarters as Kevin highlighted in his prepared comments as we announced the acquisition, is we do expect the deal to be accretive in our fiscal third quarter. And a fair amount of that comes from obviously a lot of cost synergy. As we look at it, we expect between the two organizations that we're probably going to be consolidating somewhere between 150 and 200 people as well as a number of different areas where we see cost savings on the manufacturing side and corporate governance and overhead, as well as I think improvements in the packaged saver gross margin and some pricing items that we can do there. But, a lot of the value proposition will take us a couple quarters to fully work it into the system but for the moment we do see a loss of cost synergy there.

Ryan Hutchinson - Lazard Capital Markets

So in doing my math, you're talking in fiscal 2010 well north of $0.50 accretion if you do this right, is that fair?

Brian M. NeSmith

I couldn't speak to fiscal year 2010. For you to do that model, I think if you the revenue you highlighted is clearly in the line for what we believe we can drive that revenue and then we do see ourselves growing overall as a company in our core business notwithstanding the slowdown in the US, so you factor that in and then the cost energies I think I'll have to leave it to you to model 2010.

Operator

Your next question comes from Erik Suppiger - Signal Hill.

Erik Suppiger - Signal Hill Group LLC

First off, on Packeteer you've had a sense to get a better feel for people coming over. Do you have a sense how many sales teams at this point you would expect to come over from Packeteer?

Brian M. NeSmith

I think that what we highlighted in the prepared comments is that we think there's probably about 50 teams that we would bring over. We do expect a bit of attrition there. It's not our intent to have any attrition but to the extent that we see that attrition we would back-filling with new hires, so roughly on the order of I think somewhere between 40 to 50 teams as we look out over the next two quarters.

Erik Suppiger - Signal Hill Group LLC

When you look at their business, did you say that you would expect the Packeteer revenues on the product side stay consistent? And by that the question that I'm getting at is, do you think that if you're going to be getting, are you going to be maintaining the same products that they had on the iShaper or the WAN optimization products? Aare you concerned that their pipeline is going to diminish if the development of that product isn't going to be maintained?

Brian M. NeSmith

So to answer the question maybe a different way, when we looked at Packeteer and what we wanted to acquire there, our attraction to that technology inside the company was in a couple of areas but mainly with the PacketShaper product and the application classification in QoS and application performance management capabilities, so going forward I would expect that the revenue that we would do as a combined entity would primarily comes from the PacketShaper technologies and enhancements and extensions we would be making to that technology, not from the iShared iShaper or the SkyX products. I would not expect really any kind of significant revenue from those on a going forward basis. We would be looking to incorporate certain aspects of the technology around iShared and iShaper into our WAN optimization product line as well as some of the mobility client functionality into our Proxy client functionality, so we do think there is valuable technology and expertise inside Packeteer but fundamentally the revenue would be driven more about the PacketShaper product line.

Erik Suppiger - Signal Hill Group LLC

Then the question I guess I'd have is, do you think that you're going to be able to maintain a similar revenue stream on the product side for Packeteer even without the meaningful contribution from their iShaper and WAN optimization products? Is that correct?

Brian M. NeSmith

That's correct.

Erik Suppiger - Signal Hill Group LLC

Then, just to understand, I want to make sure, you said Packeteer by either the third or fourth quarter of next year will be contributing 17% to 18% of your revenue, is that right?

Kevin S. Royal

Of this fiscal year what we said is our operating profit would be about 17% to 18% actually by the fourth quarter of 2009.

Erik Suppiger - Signal Hill Group LLC

Last question or two questions, the tax rate for next year is still expected to be 30%, no change on that?

Kevin S. Royal

That is the rate we're using, yes, for our long-term tax rate.

Erik Suppiger - Signal Hill Group LLC

And then you said that you would expect, excluding Packeteer, your next quarter to be fairly flat, correct?

Kevin S. Royal

That is correct on revenue and spending.

Erik Suppiger - Signal Hill Group LLC

Would you expect North America to be down and international to be up, is that how we should interpret that?

Brian M. NeSmith

No, I don't think we would be that pessimistic. One of the things we did this quarter is, although we saw the pipeline grow in all the geographies, what we did do is change from our forecasting standpoint the expected closure rate on larger deals and scrub that out of our forecast. But even with those changes we would expect North America to roughly probably be flat, maybe up a little bit, but flat.

Erik Suppiger - Signal Hill Group LLC

So you would expect both North America and international would be flat?

Brian M. NeSmith

In broad senses, yes. We're being a bit cautious here obviously given what we just came off of in the last quarter, but yes if you look at things overall. And that's why we're being a little bit hesitant here because we're uncertain as to how the economic conditions are going to continue to effect business as we go into Q1.

Erik Suppiger - Signal Hill Group LLC

Lastly, what was the contribution from North America in the quarter? I missed that.

Kevin S. Royal

We're looking it up; just a minute here.

Operator

Your next question comes from Scott Zeller - Needham & Company.

Scott Zeller - Needham & Company

I wanted to ask again about the US market outlook. I believe you said earlier that you're not expecting to see growth in the US for several quarters?

Brian M. NeSmith

That's correct.

Scott Zeller - Needham & Company

Can you just give us some more color on why you think it's going to be that long a stretch before you see any growth?

Brian M. NeSmith

As we start looking at the overall opportunity pipeline in North America and then we adjusted the closer rate around the larger deal opportunities that just points to the US not growing in any kind of significant way for the next couple quarters. Unless that closer rate changes then we would see then the growth start to come back into North America but that's not our expectation.

Scott Zeller - Needham & Company

And is there any sort of product specific color you could offer around perhaps, I'd be interested in the WAN optimization business and I know that everything is sold as a combined product now but when you hear interest from customers and deal cycles, is there a pull back at all on a specific area of the products?

Brian M. NeSmith

No. In some of the large deals we saw some of them were WAN optimization, some of them were traditional secure web gateway proxy deals, so I don't see any correlation around to the two different market segments.

Operator

Your next question is from Joshua Jabs - Roth Capital Partners LLC.

Joshua Jabs - Roth Capital Partners LLC

There has been some discussion of some of the slowdowns going over to Europe. Can you just kind of talk about what you're seeing over there and sort of what the expectations more granular at least within the UK are within Europe right now?

Brian M. NeSmith

The only thing that I think that we can say, and we've somewhat already factored this in, is that financial services broadly speaking is an area that's struggling even outside of North America we've seen some challenges there. Other parts of Europe seem to be actually functioning fairly well and even when we talk about international I would probably emphasize the Middle East and Asia even more than Europe. So where we see the strongest growth potential is really around Asia and the Middle East but still seeing reasonable growth in Europe.

Joshua Jabs - Roth Capital Partners LLC

You've released I think a couple of different presentations on the road map and getting in front of both your sales force and the sales force of Packeteer. Can you give us a little more color on how the plans are being received on PacketShaper and then maybe also on the end of lifing of some of these products?

Brian M. NeSmith

We haven't announced anything specific to every product, what's going to happen and the transition with that. Part of that is the restrictions we have around, rules related to the tender offering on what we can and cannot do in regards to that business. After the close we would expect and we do have a pretty very obviously clear idea of what we're going to do, but we can't provide as much clarity as we would like related to some of the restrictions there. That being said, we do think that there's a lot of opportunity and the emphasis for us is on the PacketShaper product line. Not only as it is right now, I think that a lot of that community looks at the PacketShaper product as really a QOS traffic management box and it clearly has those capabilities but we're excited about the potential of that product not only in that area but application classification and application performance management and I think there's actually growth opportunities specifically around application performance management. In my mind, one of the hidden jewels inside of Packeteer is a management product they call Intelligent Center which is a reporting product specifically around some of the application performance reporting and one of the things that we think fits both from a security and an acceleration standpoint is being able to give customers visibility into what's running on their network is a critical set of capabilities and the PacketShaper product combined with the Intelligent Center I think is one of the things that is going to allow us I think to extend the life and continue to grow that PacketShaper business.

Joshua Jabs - Roth Capital Partners LLC

Brian, were there any changes from what you had originally expected and then based on feedback that you heard from your customers? Did you guys have any changes in your plan for the different product lines?

Brian M. NeSmith

At a high level, no. From the standpoint of feedback that we did get in certain parts of the market, I don't think there's been much of a change there. There's been changes obviously in some of the specific implementations and details on how functionality gets integrated and how our organizations are put together, but fundamentally no, nothing at a high level that effects how we look at the revenue models.

Operator

Your next question is from Rohit Chopra - Wedbush Morgan.

Rohit Chopra - Wedbush Morgan Securities, Inc.

I had three questions, how long is the sales cycle now in North America and what is the close rate? I know you said you are going to change the close rate, but what is the close rate?

Brian M. NeSmith

I don't think we've disclosed the closer rate there. I think the only thing we've highlighted is that especially around larger deals it's not nearly what it has been historically but I don't think we've disclosed that close rate. The sales cycle, I couldn't tell you the average amount. What I do know is that it's longer especially for larger deals, it's definitely longer pretty much everywhere. Any larger deal especially as you get into something north of $1 million the sales cycle seems to be extended in some cases even where you received approval and you think you're moved to purchasing, it may actually go back through that cycle again due to just changing economic conditions and how companies are dealing with the changing environment.

Rohit Chopra - Wedbush Morgan Securities, Inc.

The other question was, I remember a couple quarters I asked you about new things that you were working on and I think it was a conference call where I asked you about visibility and you said that you're working on visibility internally. So how fast or how far do you think you've come by adding Packeteer? Like how long would it have taken you to develop it internally and now you've purchased it, so what's the jump?

Brian M. NeSmith

I think to get where the PacketShaper product what it offers in the way of visibility would have been a multi-year development for us. And it's not simply the time it would have taken for us to do that but also the opportunity costs in that we would have had those people not doing other things in that area. But it would have been a significant development. It would have taken us a long time to get to the richness and completeness that Packeteer has. I think one of the things that almost everyone would concede when they look at Packeteer and the PacketShaper product is just the rich set of application classification and QoS capabilities that they bring to the table. As an enterprise, if you want a product that gives you very fine granulated control over all the critical business applications, PacketShaper's the product that people choose to do that.

Rohit Chopra - Wedbush Morgan Securities, Inc.

And then lastly on Packeteer, I just wanted to ask you, what are you thinking of adding to the PacketShaper product which would, I guess there would be some R&D in there, what would you add to it to enhance its capabilities?

Brian M. NeSmith

I think two things in my mind. There's a bunch of smaller features but the two big areas of investment thematically is one is classifying even more applications than they current do so they support currently today between 500 and 600 different applications and in my view we want to classify everything that can be classified to the point that if it can't be classified, it is probably something that shouldn't be running on the corporate network so, a lot of investment in further application classification. The second item is for applications that we do classify, how do we report the performance of those applications both response times throughput and characteristics of those applications and tracking and monitoring those both historically and in real time. Those are thematically the two areas is that application classification as well as application performance management.

Operator

We have a question from Rajesh Ghai - ThinkPanmure.

Rajesh Ghai - ThinkPanmure LLC

I had a question on the Packeteer acquisition. You spoke about attrition in the sales force. I was just curious about the steps you're taking to retain the technical talent from Packeteer?

Brian M. NeSmith

A couple things, one we have put in place some retention bonus and will obviously be looking to do some things as people move over to the company but it's the financial incentives, frankly, engineers in general are motivated and look to be at a company where they get a chance to develop innovative technology that customers are going to use. And I think that the Packeteer employees are excited about how I think we can extend the PacketShaper technology and some of the functionality that we can offer there and the success we had in the WAN optimization market in developing capabilities in that area. Engineers in the end are motivated by working on cool technology that customers in the end use and deploy and I think that's what we've tried to really make clear to those engineers what we're going to be able to do and what they're going to be able to offer and how they'll be able to participate and be a part of Blue Coat and our success in doing those things.

Rajesh Ghai - ThinkPanmure LLC

You said that you've added seven teams this quarter, were they in the Middle East and Asia or were they in North America?

Brian M. NeSmith

There was a little bit in North America but I think it was predominantly outside the US.

Rajesh Ghai - ThinkPanmure LLC

And going forward do you plan to add more sales teams in Asia Pac or do you kind of foresee sales and marketing expenditure kind of the sales and marketing teams going to be the same as what you had last quarter?

Brian M. NeSmith

It gets a bit confusing because once we combine with Packeteer we pick up a number of teams overall and I don't think we've given guidance. Even after we complete the acquisition of Packeteer we would expect to continue to grow our sales channel and the capacity that we have in our organization, to continue to grow the overall Company so there will be growth in that organization. I think as Kevin highlighted obviously we want to drive the synergies that we need to between the two organizations to get to the operating profit that we outlined toward the end of this fiscal year but there will be continued growth and investment in the sales channel.

Rajesh Ghai - ThinkPanmure LLC

How do you see that trending as a percentage of sales? Is that going to be more or less the same or do you see that growing in absolute your terms?

Brian M. NeSmith

As a percentage obviously I would expect it to go down through the course of the fiscal year.

Rajesh Ghai - ThinkPanmure LLC

One last question [inaudible]. Riverbed announced their broad services platform and you've gone ahead and acquired Packeteer. Do you see that as a broad trend of broadening the ban optimization termination platform kind of causing customers to take a pause and seeing where this investment will evolve before making purchases or do you think it's not being affected right now?

Brian M. NeSmith

I don't think that's much of an issue in the context of what's going on here. I think that this is primarily macroeconomic conditions that's driving everything here.

Operator

Your next question is from Alex Kurtz – Merriman Curhan Ford & Co.

Alex Kurtz - Merriman Curhan Ford & Co.

Brian if you were to look back at your deals that closed in North America, would you say that, I'm just referring to your earlier comments, that maybe you're mid-market and commercial deals increased as a percent of mix relative to your enterprise deals this quarter?

Brian M. NeSmith

No, I think that we saw fewer larger deals so to the extent that that created that situation that might be true but I've not actually looked at it quite in the way you're describing there and I'd have to go back and do some work to figure that out. I guess the part that's difficult to say is that, I'm just thinking of the ones I know off of the top of my head, there were a lot of large companies that bought $50,000 to $100,000 increments of deals so I don't think that would necessarily what your highlight would equate. I'm not sure the mix changed in that regard.

Alex Kurtz - Merriman Curhan Ford & Co.

Okay. As far as strength in verticals overseas, can you just give us sort of a highlight of what industries are doing really well in AP and EMEA for you right now?

Brian M. NeSmith

I think other than financial services things look fairly normal.

Alex Kurtz - Merriman Curhan Ford & Co.

So no change from the prior quarter then?

Brian M. NeSmith

No, not really.

Alex Kurtz - Merriman Curhan Ford & Co.

Kevin, just for direction of gross margin, would you expect that, I just want to make sure I heard your comments earlier, do you expect gross margin to be roughly in line with what you saw last quarter for the next quarter?

Kevin S. Royal

Yes, roughly we're in line. The gross profit for the quarter is $76.8 million and we're using 77% for our planning purposes.

Operator

Your next question is from Rob Owens - Pacific Crest Securities,

Rob Owens - Pacific Crest Securities

Just a quick question with regard to the 17% to 18% operating margin target by Q4 for the combined entity, does that still incorporate the $10.5 million and I think $11 million cost savings in Q3 and Q4 respectively?

Kevin S. Royal

It does.

Rob Owens - Pacific Crest Securities

Okay, so there's been no changes to the potential synergy there?

Kevin S. Royal

No, no change on the estimates we earlier provided.

Operator

Your next question is from Gabriel Lowy - Collins Stewart LLCS.

Gabriel Lowy - Collins Stewart LLC

Two quick questions, most of the others have been answered. You've talked about larger deals getting pushed out, are you seeing any similar type of pattern in small to mid-size businesses to the degree that your visibility allows? That's the first question. The second one, in terms of follow on investment into PacketShaper, are you looking to extend that with real-time end user monitoring as well?

Brian M. NeSmith

I can answer the second question a bit easier than the first one. Yes, we do think as part of the application performance monitoring is the ability to see what the user sees and be able to characterize that experience and report on that is I think one of the areas that from an overall product standpoint we can add a lot of value and we think that the PacketShaper technology would be the basis of being able to do a lot of that. There are actually some things on our core ProxySG product that are very critical and relevant to that as well so it's actually a welding of what PacketShaper does and what our ProxySG does to actually deliver that kind of functionality. As to the first question, we talked about obviously the slowdown on larger deals but we did see I'd say a broader base pull back in a lot of the deals across the size more heavily weighted to the larger deals but it wasn't exclusive to just large deals.

Operator

Your last question comes from Samuel Wilson – JMP Securities.

Samuel Wilson - JMP Securities

Just two quick questions, I'm sorry I missed headcount for the quarter.

Kevin S. Royal

The regular full-time head count at the end of the quarter was 976.

Samuel Wilson - JMP Securities

And inside Q1, can you give me granularity roughly when you think Packeteer will close?

Kevin S. Royal

The tender offer is scheduled to expire on May 30 and provided that we get sufficient shares in that tender offer and all the closing conditions are satisfied, the merger should close promptly thereafter.

Operator

I'd like to turn the conference back over then to Company management for any closing comments.

Daniel Levy

Again, we’d like to thank you for joining us on the call today. A replay of today's call will be available at 320-365-3844, pass code 923369, beginning Friday, May 23, 2008 at 1:00 pm Eastern Time. An audio archive will also be available on our website. Have a great day and we look forward to speaking with you again soon. Thanks a lot.

Operator

Thank you. 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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