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| ARST > SEC Filings for ARST > Form 10-Q on 9-Sep-2009 | All Recent SEC Filings |
9-Sep-2009
Quarterly Report
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the (1) unaudited condensed
consolidated financial statements and the related notes thereto included
elsewhere in this Quarterly Report on Form 10-Q, and (2) the audited
consolidated financial statements and notes thereto and management's discussion
and analysis of financial condition and results of operations for the fiscal
year ended April 30, 2009 included in our Annual Report on Form 10-K filed with
the Securities and Exchange Commission, or the SEC, on July 9, 2009. This
Quarterly Report on Form 10-Q contains "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These statements
are often identified by the use of words such as "may," "will," "expect,"
"believe," "anticipate," "intend," "could," "estimate," or "continue," and
similar expressions or variations. Such forward-looking statements are subject
to risks, uncertainties and other factors that could cause actual results and
the timing of certain events to differ materially from future results expressed
or implied by such forward-looking statements. Factors that could cause or
contribute to such differences include, but are not limited to, those identified
herein, and those discussed in the section titled "Risk Factors", set forth in
Part II, Item 1A of this Form 10-Q and in our other SEC filings, including our
Annual Report on Form 10-K for the fiscal year ended April 30, 2009. We disclaim
any obligation to update any forward-looking statements to reflect events or
circumstances after the date of such statements.
Overview
We are a leading provider of security and compliance management solutions
that protect enterprises and government agencies. Our products help customers
comply with corporate and regulatory policy, safeguard their assets and
processes and control risk. Our platform collects and correlates user activity
and event data across the enterprise so that businesses can rapidly identify,
prioritize and respond to compliance violations, policy breaches, cybersecurity
attacks and insider threats. Our products collect and correlate massive numbers
of events from thousands of security point solutions, network and computing
devices and applications, enabling intelligent identification, prioritization
and response to compliance and corporate policy violations, and external and
insider threats and compliance. We also provide complementary software that
delivers pre-packaged analytics and reports tailored to specific security and
compliance initiatives, as well as appliances that streamline event log
collection, storage, analysis and reporting.
We were founded in May 2000 and first sold our initial ESM product in
June 2002. We initially funded our operations primarily through convertible
preferred stock financings that raised a total of $26.8 million. Our revenues
have grown from $32.8 million in fiscal 2005 to $136.2 million in fiscal 2009,
and were $34.6 million in our first quarter of fiscal 2010.
In February 2008, we completed our IPO, in which we sold 6,000,000 shares of
common stock, at an issue price of $9.00 per share. We raised a total of
$54.0 million in gross proceeds from our IPO, or $45.9 million in net proceeds
after deducting underwriting discounts of $3.8 million and offering expenses of
$4.3 million.
We achieved positive cash flows from operations in fiscal 2004 through 2009.
We generated $9.0 million and $3.8 million in cash from our operating activities
during the three months ended July 31, 2009 and 2008, respectively, and we
generally expect to continue to generate positive cash flows from operating
activities on an annual basis. As of July 31, 2009, we had cash and cash
equivalents and accounts receivable of $124.6 million, and an aggregate of
$17.2 million in accounts payable and accrued liabilities.
Important Factors Affecting Our Operating Results and Financial Condition
We believe that the market for our products is in the early stages of
development. We have identified factors that we expect to play an important role
in our future growth and profitability. These factors are:
Sales of ESM Products and Appliance Products to New Customers. The market for
security and compliance management software solutions is growing, with new
purchases often driven by corporate compliance initiatives. We typically engage
in a proof of concept with our customers to demonstrate the capabilities of our
ESM products in their specific environment. A new sale usually involves the sale
of licenses for one or more ESM Managers, licenses for the number and type of
devices the customer intends to manage with ArcSight ESM, licenses for our
console and web interfaces, installation services, training and an initial
maintenance arrangement. In many cases, customers will also purchase one of our
complementary software modules which enable them to implement specific sets of
off-the-shelf rules for our event correlation engine that address specific
security and compliance issues and business risks. In addition, customers may
purchase our ArcSight Logger appliances to address their log archiving needs. A
key component of our
growth will depend on our ability to sell our products to new customers and our
subsequent ability to generate follow-on sales from these customers. We also
anticipate that a growing proportion of future new customers will be a result of
initial sales of ArcSight Logger, our new ArcSight Express product and our other
products sold in an appliance form factor.
Continued Sales to Our Installed Base. Many customers make an initial
purchase from us and then decide whether to use our products with respect to a
larger portion of their business and technology infrastructure or buy additional
complementary products from us. Thus, a key component of our growth will be our
ability to successfully maintain and further develop the relationships with our
existing customers.
Development and Introduction of New Products. We believe it is important that
we continue to develop or acquire new products and services that will help us
capitalize on opportunities in the security and compliance management market.
Examples of new product introductions in fiscal 2009 included our Compliance
Insight Package for NERC CIP standards 002-009 and our ArcSight Express product.
We continue the enhancement of our ESM products and solutions, such as the
introduction of ESM appliances in June 2008, the integration with the Cisco
Mobility Services Engine announced in May 2009, and the introduction of an
all-in-one PCI log management appliance in July 2008 and ArcSight Logger 3.0 in
September 2008. In addition, we continue to develop and release appliance
versions of our software products and updates to complementary solution packages
for our ArcSight Logger product.
Development of Our Channel Network. Historically, we have sold our products
primarily through our direct sales force, with sales to government or
international purchasers through resellers and systems integrators. We recently
expanded our sales channel to assist us in penetrating the mid-market,
particularly as we expanded our appliance-based offerings. We believe that our
current and any new appliance-based products that we develop will be sold more
effectively through resellers and, if we are successful in introducing these new
products, we will become more dependent on the development of an effective
channel network. Further training, certification and development of our existing
channel partners will be a key factor in the success of this strategy.
Sources of Revenues, Cost of Revenues and Operating Expenses
Our sales transactions typically include the following elements: a software
license fee paid for the use of our products in perpetuity or, in limited
circumstances, for a specified term; an arrangement for first-year support and
maintenance, which includes unspecified software updates and upgrades; and
professional services for installation, implementation and training. We derive
the majority of our revenues from sales of software products. We introduced
complementary appliance products in fiscal 2007. We sell our products and
services primarily through our direct sales force. Additionally, we utilize
resellers and systems integrators, particularly in sales to government agencies
and international customers.
We recognize revenues pursuant to American Institute of Certified Public
Accountants, or AICPA, Statement of Position, or SOP, No. 97-2, Software Revenue
Recognition, as amended by SOP No. 98-9, Software Revenue Recognition with
Respect to Certain Arrangements, or collectively, SOP 97-2, which, if revenues
are to be recognized upon product delivery, requires among other things
vendor-specific objective evidence of fair value, or VSOE, for each undelivered
element of multiple element customer contracts.
Revenues in fiscal 2007 and prior years were impacted by multiple element
sales transactions consummated for which the revenues were deferred because we
did not have vendor-specific objective evidence of fair value, or VSOE, for some
product elements that were not delivered in the fiscal year of the transaction.
Following identification in mid-fiscal 2007 of transactions with such
undelivered elements, with respect to some of these transactions, we and our
customers amended the contractual terms to remove the undelivered product
elements and in other instances we have since delivered such product elements.
The net impact of these transactions increased revenues in the three months
ended July 31, 2009 and 2008, by $0.7 million and $0.2 million, respectively. As
of July 31, 2009 and April 30, 2009, deferred revenues included $0.9 million and
$1.6 million, respectively, related to transactions such as these.
In addition, if we determine that collectibility is not reasonably assured,
we defer the revenues until collectibility becomes reasonably assured, generally
upon receipt of cash. Deferred revenue and accounts receivable are reported net
of adjustments for sales transactions invoiced during the period that are
recognized as revenue in a future period once cash is received and all other
revenue recognition criteria have been met, which are sometimes referred to as
net-down adjustments. Accordingly, we believe that in order to understand the
change in both deferred revenue and accounts receivable from one period to
another the impact of these net-down adjustments should be considered.
Historically sales to the U.S. government have represented a significant
portion of our revenues, while international sales have represented a smaller
portion of our revenues. We expect revenues from sales to agencies of the U.S.
government to continue to grow both in absolute dollars and as a percentage of
revenues. In addition, we expect that sales to customers outside of the United
States will continue to grow in absolute dollars.
Product Revenues
Product revenues consist of license fees for our software products and,
beginning in fiscal 2007, also includes revenues for sales of our appliance
products. License fees are based on a number of factors, including the type and
number of devices that a customer intends to monitor using our software as well
as the number of users and locations. In addition to our core solution, some of
our customers purchase additional licenses for optional extension modules that
provide enhanced discovery and analytics capabilities. Sales of our appliance
products consist of sales of the appliance hardware and associated perpetual
licenses to the embedded software. We introduced our first appliance products in
June 2006 and our first ArcSight Logger product, our most widely adopted
appliance product to date, in December 2006. Appliance fees are based on the
number of appliances purchased and, in some cases, on the number of network
devices with which our customer intends to use the appliances. We generally
recognize product revenues at the time of product delivery, provided all other
revenue recognition criteria have been met.
Historically, we have engaged in long sales cycles with our customers,
typically three to six months and more than a year for some sales, and many
customers make their purchase decisions in the last month of a fiscal quarter,
following procurement trends in the industry. Further, average deal size can
vary considerably depending on our customers' configuration requirements,
implementation plan and budget availability. As a result, it is difficult to
predict timing or size of product sales on a quarterly basis. In addition, we
may fail to forecast sufficient production of our appliance products due to our
limited experience with them, or we may be unable to physically deliver
appliances within the quarter, depending on the proximity of the order to the
end of the quarter. These situations may lead to delay of revenues until we can
deliver products. The loss or delay of one or more large sales transactions in a
quarter could impact our operating results for that quarter and any future
quarters into which revenues from that transaction are delayed.
In addition, we believe that our product revenue has been somewhat seasonal
historically, with the first quarter ending July 31 of our fiscal year typically
having relatively lower product revenue and the fourth quarter ending April 30
of our fiscal year typically having relatively higher product revenue. We
believe that this seasonality results from a number of factors, including:
• the budgeting, procurement and work cycles of our customers, including
customers in the public sector;
• the timing of our annual sales "club" for top performers and annual training for our entire sales force in our first fiscal quarter;
• seasonal reductions in business activity during the summer months in the United States, Europe and certain other regions;
• sales to customers with a standard December 31 fiscal year end that may positively impact our license revenue in the third quarter of our fiscal year; and
• the structure of our direct sales incentive and compensation program, which may reinforce the tendency of our direct sales team to book the largest volume of deals toward the end of our fiscal year.
The timing of our fiscal quarters and the U.S. federal government's
September 30 fiscal year end may impact product sales to governmental agencies
in the second quarter of our fiscal year, offsetting the otherwise seasonal
downturn in later summer months. We expect these seasonal factors to continue to
impact our business in the future, and any seasonality that we experience may
cause fluctuations in our operating results. We believe that our rapid
historical growth may have overshadowed the nature or magnitude of seasonal or
cyclical factors that might have influenced our business to date. They may do so
again in the future. Seasonal or cyclical variations in our operations may
become more pronounced over time and may materially adversely affect our results
of operations in the future.
As of July 31, 2009 and April 30, 2009, deferred product revenues were
$7.9 million and $9.8 million, respectively. Included in deferred product
revenues as of July 31, 2009 and April 30, 2009 was $0.7 million and
$1.3 million, respectively, related to multiple element arrangements where one
or more product elements for which we did not have VSOE remained undelivered.
The remainder of deferred product revenues as of July 31, 2009 and April 30,
2009 was $7.2 million and $8.5 million, respectively, and primarily related to
product revenues to be recognized ratably over the term of the maintenance
arrangements, prepayments in advance of
delivery and other delivery deferrals. Deferred revenue and accounts receivable
are reported net of adjustments for sales transactions invoiced during the
period that are recognized as revenue in a future period once cash is received
and all other revenue recognition criteria have been met. These net-down
adjustments decrease both accounts receivable and deferred revenue. Accordingly,
we believe that in order to understand the change in both deferred revenue and
accounts receivable from one period to another the impact of these net-down
adjustments should be considered. As of July 31, 2009 and April 30, 2009,
deferred product revenues of $7.9 million and $9.8 million, respectively, were
reduced by net-down adjustments of $5.1 million and $5.4 million, respectively.
Our operating results in any particular quarterly period in fiscal 2010 may be
similarly impacted by the recognition of previously deferred revenue, where the
associated costs were recorded in prior periods. See "Critical Accounting
Policies, Significant Judgments and Estimates-Revenue Recognition" and Note 2 to
our Condensed Consolidated Financial Statements ("Significant Accounting
Policies-Revenue Recognition") elsewhere in this report.
Maintenance Revenues
Maintenance includes rights to unspecified software product updates and
upgrades, maintenance releases and patches released during the term of the
support period, and internet and telephone access to maintenance personnel and
content. Maintenance revenues are generated both from maintenance that we agree
to provide in connection with initial sales of software and hardware products
and from maintenance renewals. We generally sell maintenance on an annual basis.
We offer two levels of maintenance-standard and premium. The premium level is
for customers that require 24-hour coverage seven days a week. In most cases, we
provide maintenance for sales made through channel partners. In addition, we
sell an enhanced maintenance offering that provides frequent security content
updates for our software. Maintenance fees are treated as deferred revenue at
the time the maintenance agreement is initiated and recognized ratably over the
term of the maintenance agreement. As our customer base expands, we expect
maintenance revenues to continue to grow, as maintenance is sold to new
customers and existing customers renew.
As of July 31, 2009, deferred maintenance revenues were $30.9 million, of
which $26.5 million represented current deferred maintenance revenues. As of
April 30, 2009, deferred maintenance revenues were $32.4 million, of which
$26.7 million represented current deferred maintenance revenues. Deferred
maintenance revenues relate to advanced payments for support contracts that are
recognized ratably. Included in deferred maintenance revenues as of July 31,
2009 and April 30, 2009, were $0.1 million and $0.2 million, respectively,
related to multiple element arrangements where one or more product elements for
which we did not have VSOE remained undelivered. For the three months ended
July 31, 2009, there was $0.1 million of revenues recorded related to multiple
element arrangements. As of July 31, 2009 and April 30, 2009, the deferred
maintenance revenues of $30.9 million and $32.4 million, respectively, were
reduced by net-down adjustments of $2.9 million and $2.6 million, respectively.
Net-down adjustments decrease both accounts receivable and deferred revenue and
typically relate to billed but unpaid customer transactions for maintenance
renewal support terms where services have not yet been provided, or where
revenue from the customer is only recognized when cash has been paid and all
other revenue recognition criteria have been met. See "Critical Accounting
Policies, Significant Judgments and Estimates-Revenue Recognition" and Note 2 to
our Condensed Consolidated Financial Statements ("Significant Accounting
Policies-Revenue Recognition") elsewhere in this report.
Services Revenues
Services revenues are generated from sales of services to our customers,
including installation and implementation of our software, consulting and
training. Professional services are not essential to the functionality of the
associated software products. During fiscal 2009, we entered into an increasing
number of service engagements to staff and manage the security operation
centers, SOCs, of certain large customers. These SOC engagements are typically
longer in duration than other services engagements and support the day-to-day
monitoring of customer SOC environments. We generally sell our services on a
time-and-materials basis and recognize revenues as the services are performed.
Services revenues have generally increased over time as we have sold and
delivered installation and training services to our new customers and continued
to sell training and consulting services to our existing customers, including
our new SOC services.
As of July 31, 2009 and April 30, 2009, deferred service revenues were
$3.0 million and $2.9 million, respectively, in each case all of which
represented current deferred services revenues. Deferred services revenues
relate to customer payments in advance of services being performed. As of
July 31, 2009 and April 30, 2009, the deferred service revenues of $3.0 million
and $2.9 million, respectively were reduced by net-down adjustments of
$0.6 million and $1.0 million, respectively. Net-down adjustments decrease both
accounts receivable and deferred revenue and typically relate to billed but
unpaid customer transactions for service engagements where services have not yet
been provided, or where revenue from the customer is only recognized when cash
has been paid and all other revenue recognition criteria have been met. See
"Critical Accounting Policies, Significant Judgments and Estimates-Revenue
Recognition" and Note 2 to our Condensed Consolidated Financial Statements
("Significant Accounting Policies-Revenue Recognition") elsewhere in this
report.
Cost of Revenues
Cost of revenues for our software products consists of third-party royalties
and license fees for licensed technology incorporated into our software product
offerings. Cost of revenues for appliance products consists of the hardware
costs of the appliances and third-party royalties for licensed technology. The
cost of product revenues is primarily impacted by the mix of software and
appliance products as well as the relative ratio of third-party royalty bearing
products included in software sales transactions. Sales of our appliance
products are generally at a lower gross margin than sales of our software
products.
Cost of maintenance revenues consists primarily of salaries and benefits
related to maintenance personnel, royalties and other out-of-pocket expenses,
and facilities and other related overhead.
Cost of services revenues consists primarily of the salaries and benefits of
personnel, travel and other out-of-pocket expenses, facilities and other related
overhead that are allocated based on the portion of the efforts of such
personnel that are related to performance of professional services, and cost of
services provided by subcontractors for professional services. Services gross
margin may fluctuate as a result of periodic changes in our use of third party
service providers, resulting in lower or higher gross margins for these
services.
We intend to increase sales to the mid-market, a goal that we believe will be
aided by our recent introduction of additional appliance products. We expect the
percentage of our mid-market sales made through our distribution channel will be
greater than it has been to date. We also expect a high percentage of our
international sales to continue to be made through our distribution channel.
Sales through the channel tend to be at a lower gross margin than direct sales.
As a result, we may report lower gross margins in future periods than has been
the case for prior periods.
Operating and Non-Operating Expenses
Research and Development Expenses. Research and development expenses consist
primarily of salaries and benefits of personnel engaged in the development of
new products, the enhancement of existing products, quality assurance activities
and, to a lesser extent, facilities costs and other related overhead. We expense
all of our research and development costs as they are incurred. We expect
research and development expenses to increase in absolute dollars for the
foreseeable future as we continue to invest in the development of our products.
Sales and Marketing Expenses. Sales and marketing expenses consist primarily
of salaries, commissions and benefits related to sales and marketing personnel
and consultants; travel and other out-of-pocket expenses; expenses for marketing
programs, such as for trade shows and our annual users conference, marketing
materials and corporate communications; and facilities costs and other related
overhead. Commissions on sales of products and maintenance are typically accrued
and expensed when the respective revenue elements are ordered. Commissions on
sales of services are typically accrued and expensed when the services are
ordered. We also pay commissions for channel sales not only to our channel sales
force but also to our direct sales force in an effort to minimize channel
conflicts as we develop our channel network. We intend to hire additional sales
personnel, initiate additional marketing programs and build additional
relationships with resellers and systems integrators on a global basis.
Accordingly, we expect that our sales and marketing expenses will continue to
increase for the foreseeable future in absolute dollars.
General and Administrative Expenses. General and administrative expenses
consist primarily of salaries and benefits related to general and administrative
personnel and consultants; accounting and legal fees; insurance costs and
facilities costs and other related overhead. We expect that, in the future,
general and administrative expenses will increase in absolute dollars as we add
personnel and incur additional costs related to the growth of our business and
additional legal, accounting and other expenses in connection with our reporting
and compliance obligations as a public company.
Other Income (Expense), Net. Other income (expense), net consists of interest
earned on our cash investments and foreign currency-related gains and losses.
Our interest income will vary each reporting period depending on our average
cash balances during the period and the current level of interest rates. Our
foreign currency-related gains and losses will also vary depending upon
movements in underlying exchange rates.
Accounting for Income Taxes. Our provision for income taxes is calculated in
compliance with SFAS No. 109, Accounting for Income Taxes, or SFAS 109, and
other related guidance, and generally consists of tax expense related to current
period earnings. We estimate income taxes in each of the jurisdictions in which
we operate. This process involves determining income tax expense together with
calculating the deferred income tax expense related to temporary differences
resulting from the differing treatment of items for tax and accounting purposes.
Deferred tax assets are recognized for deductible temporary differences, along
with net operating loss carry-forwards, if it is more likely than not that the
tax benefits will be realized. Deferred tax assets and liabilities are measured
using enacted tax rates in effect for the year in which those temporary
differences are expected to be recovered or settled. These temporary differences
result in deferred tax assets and liabilities, which are included within the
consolidated balance sheets.
To the extent a deferred tax asset cannot be recognized a valuation allowance
is established to reduce our deferred tax assets to the amount that is more
likely than not to be realized. A valuation allowance is maintained until
sufficient evidence exists to support the reversal of all or some portion of
these allowances. Should the actual amounts differ from our estimates, the
. . .
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