Netscout Systems Inc (NTCT) 2004 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Please continue to hold. Your call will begin shortly, and sorry for the delay.

Ladies and gentlemen, thank you for standing by, and welcome to NetScout's Second Quarter Operating Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will be conducting a question-and-answer session. Instructions will be given to you at that time. As a reminder, this conference call is being recorded.

With us today is NetScout's president and CEO, Mr. Anil Singhal. He is accompanied by NetScout's CFO, Mr. David Sommers. Also with Mr. Singhal is NetScout's director of investor of relations, Ms. Cathy Taylor. At this time, for opening remarks, I would like to turn the call over to Mr. Singhal. Please go ahead, sir.

Thank you, and good afternoon, everyone. Welcome to NetScout's 2nd Quarter of Fiscal Year 2005 Conference Call, for the period ended September 30th. I will begin our call today with a brief overview of our financial results achieved this quarter, followed by a summary of our operating highlights for the recent quarter and past fiscal year. David will then review our financial results for the quarter in greater detail.

First, let me turn the call over to Cathy Taylor, Director of Investor Relations, who will read the Safe Harbor Statement.

Thank you, Anil. During the course of this conference call, we will be providing you with a discussion of the factors we currently anticipate that may influence our results, going forward. Before doing so, we want to emphasize that these forward-looking statements may involve judgments, and that individual judgments may vary. Forward-looking statements include expressed or implied statements regarding future economic and market conditions, revenues, profitability, growth, delivery and market acceptance of NetScout products.

It should be clearly understood that the projections on which we base our guidance, and our perception of the factors influencing those projections are highly likely to change over time. Although those projections and the factors influencing them will likely change, we will not necessarily inform you when they do. Our company policy is to provide guidance only at certain points in the year, such as during the quarterly earnings calls. We do not plan to otherwise update that guidance.

Actual results may differ materially from what we say today, and no one should assume later in the quarter that the comments we provide today are still valid. These and other specific factors could change - causing our projections not to be achieved. Specific risks and uncertainties are discussed in NetScout's Form 10Q for the quarter ended June 30th, 2004, on file with the SEC.

I will now turn the call back over to Anil Singhal, our CEO.

Thank you, Cathy. We are pleased with our financial performance, as we reported yet another strong quarter. Our revenue was $20.5m, compared to last quarter's revenue of $20.1m, and compared to $17.5m a year ago. We had a net after-tax profit of $1.1m, compared to last quarter's $297,000 net profit, and compared to break-even results a year ago.

Our EPS were $0.03 per share, compared to last quarter's of $0.01 per share, and compared to $0.00 per share a year ago. $0.01 of the $0.03 profitability this quarter resulted from an adjustment of $360,000 from the completion of an IRS tax audit for fiscal years 2000 through 2003.

Turning to cash. We had positive cash flow from operations, with cash increasing by $1.7m, to a total of $78.2m. This is our third consecutive quarter of increasing revenue, and while we are seeing strong sales activity, growth in IT spending is less robust than we had hoped.

In this environment, we expect to continue to grow at a steady pace. Other companies appear to be seeing similar growth constraints. Having said that, we still expect to outgrow our nearby competitor for the foreseeable future - based on the strength of our new product and market position. We are seeing evidence of that strength in a few key markets, including the federal government and various of its providers.

In addition, we are seeing strong interest in our products by resellers in Asia, fueled in part by the economic growth in that region. Overall, we are seeing heightened customer interest in our solution, and better sales activity than last year. We believe our steady revenue growth is a testimony to the market acceptance of our CDM technology.

Our CDM strategy continues to gain traction, and we are pleased with the positive feedback we are getting from our customers. Last week, we held our annual user's forum conference in Cambridge, Massachusetts. That even was sold out, with attendance up by 50 percent over last year.

Our user forum now has more than 700 members worldwide, and we had customers and resellers coming from North America, Asia and Europe. We had once thought of a user forum as a way for our customers to collaborate and exchange ideas on best practices and techniques for optimizing the value delivered by our nGenius Performance Management System.

At the conference, we presented a product and technology direction. It was hard for many of our customers about their current network management concerns and [inaudible]. We take a lot of pride in listening to our customers, and to helping products and enhancements that will [inaudible].

We heard from many customers that our unique CDM technology is on the right track, and is the most powerful performance management solution on the market, today. We used the conference as intending to get feedback directly from our customers on the major initiative that we are in the process of designing, and will be unveiling in the next few weeks. This new initiative will provide even more powerful performance management, and is the next big step in the evolution of our market-leading CDM technology.

During the conference, we also discussed applications. End-users of nGenius Flow Recorder - a product that we have [inaudible] conference calls. The nGenius Flow Recorder is a network forensic analysis tool that provides network traffic auditing and forensics. The Flow Recorder software is backing in an appliance that captures every packet that traverses the network, and stores the data on a 750 gigabit or 2 [databyte] system.

It can cover multiple segments and all network topologies. This product is important to our customers for recording data from highly sensitive, critical links. It can be used to provide analysis, tracking of sensitive content movement, trouble-shooting of low-frequency network problems, and other evidentiary forensics. The Flow Recorder is another proved point of the power of our architecture in reducing clutter in the network.

Another product announcement made during the second quarter was the new probe that is the market-first solution for performance management in the WANs using inverse multiplexing over ATM or IMA technology. The probe is available in a T1/E1 interface, and it will allow our customers to monitor applications being delivered across IMA links, as well as manage the performance of those links, in conjunction with the rest of the network.

In August, we had a reseller conference for the Asia region in Thailand. The conference was very well-attended, and included some of our top resellers across Asia. Just like the user conference in Boston last week, this reseller conference gave us an opportunity to understand the market requirements for Asia, and to further validate our CDM strategy in that part of the world.

In addition, we are pleased to have partnered with another reseller in Asia, Transition Systems - a distributor of data communications products to enterprises and governments in Southeast Asia. Transition Systems resells NetScout nGenius Solutions to its extensive network of system integrators and value-added resellers in Malaysia, Thailand and Philippines.

In the product partnership arena, we've further enhanced our partnership with Citrix by becoming a premium member of their Alliance Partner Program. We're also a sponsor of the Citrix iForum 2004, held in Florida last week. In short, we are pleased with our achievements in the last few quarters, which are directly attributable to the introduction of the CDM technology an dour nGenius Performance Management Product. We have effectively removed clutter from our customers' network management environment by delivering increased value and demanding a strong customer loyalty.

Our new technology continues to differentiate us from our competitors, and we are gaining stronger market presence. We had an opportunity to validate this at our conference last week, and we are pleased with the feedback from our customers about our future direction. We think we are on a path to steady growth, and we look forward to sharing our success story with you in the coming quarters.

With that, I would like to turn the call over to David.

Thank you, Anil. I would now like to review our quarterly financial results. Those results are contained in the financial statements included with our press release. Revenue for the second fiscal quarter of 2005 was $20.5m - an increase of 2 percent over last quarter, and 17 percent over the second quarter of fiscal 2004. Our product revenue increased 6 percent over last quarter, and increased 24 percent from year-ago.

Service revenue was down 3 percent over the last quarter, but up 9 percent year-over-year. License and royalty revenue was up 2 percent from last quarter, down 1 percent from year-ago. Revenue through our direct sales force was 36 percent, compared to 50 percent last quarter. Reseller revenue correspondingly was 64 percent of total, compared to 50 percent last quarter. This swing through the channel was driven in large part by strength in some of our channel-based markets, such as government and international.

During this quarter, we added 31 new customers worldwide, representing 15 percent of total orders - up from 8 percent in the second quarter. Among some of our largest new customers were the Tengelmann Group, a larger European retailer, Southwest Bank - a regional bank in Texas, and Redstone Federal Credit Union - a large credit union in Alabama. We had 249 repeat customers this quarter - representing 85 percent of order volume. Some of our repeat customers include Vodafone, Bell Canada, Telia and Belgacom - two European wireless companies. The US Central Command Air Forces, the IRS, the Department of Veterans Affairs, VISA, Goodyear, Consumer's Energy, Mohegan Sun and Eastman Kodak.

We had 52 customers with order volume over $100,000 this quarter, including 3 customers with orders greater than $500,000. Competitive wins totaled more than $4.1m in the quarter, involving approximately 26 deals against other leading network management vendors.

Turning now to our vertical markets. This quarter, the financial services sector representing 32 percent of order dollar volume followed by the government sector, with 21 percent of orders, and a stronger showing in health and medical at 11 percent. We also had significant orders from telecommunications, manufacturing and high-tech sectors.

During the quarter, Veritas - one of the world's largest software companies - placed a large order for nGenius probes, as part of the company's redesign and migration of its WAN, to multi-protocol label-switching, or MPLS.

This repeat order expanded the use of our solution for monitoring Veritas' LAN, to monitoring their WAN, for more than 50 remote offices. Veritas' WAN is a complex, converged network, running VPNs, Voice Over IP and QLS. Last quarter, we incorporated new features into nGenius, for monitoring application performance for companies in MPLS-based networks, because many of our customers had been hampered by reduced-application disability, when implementing MPLS services. With nGenius, Veritas will have greatly improved visibility into all critical application traffic and QS assignments on their networks, even with MPLS.

One of the new customers we added this quarter was Redstone Federal Credit Union - the largest credit union in the state of Alabama. Redstone's network is becoming increasingly critical to their business. The credit union must assure business traffic and web access for 21 remote branches, as well as the responsiveness of important services such as online loan processing, teller machine availability and internet banking.

Prior to implementing nGenius, Redstone - with limited IT resources - was having difficulty managing the performance of remote offices using portable analyzers. With nGenius, Redstone can now get a network-wide view and manage network and application performance remotely and easily from its headquarters. Redstone is a typical example of the value that nGenius can deliver to mid-market as well as top tier financial institutions.

Turning back to our financial picture. Our gross profit for the quarter was $15.5m - up 1 percent sequentially, and up 18 percent year-over-year. Gross margin was 76 percent in the quarter - down 1 point sequentially, but up 1 point year-over-year, and above our gross margin target range of 72-75 percent.

Revenue from international sales was 18 percent of total revenue - up from 14 percent last quarter, with Asia representing 7 percent for the quarter. Operating expenses in total were $14.7m - down 3 percent from last quarter, and up 11 percent year-over-year. We had operating profit of $845,000.

Net after-tax profit for the quarter was $1.1m versus the net after-tax profit of $297,000 last quarter, and versus break-even a year ago. After-tax profit this quarter was impacted by the tax adjustment of $386,000 from the completion of the IRS tax audit, as Anil mentioned.

Turning now to key balance sheet measures. Cash and marketable securities, or $78.2m - an increase of $1.7m from last quarter - and up $6m year-over-year. Accounts receivable net allowances were $9.7m, compared to $11.5m last quarter and $10.8m a year ago. Days Sales Outstanding were 42 days for the quarter - down from 51 days in the prior quarter, and below our target range of 45-55 days. Inventories were $2.9m - down slightly from last quarter.

Now for our guidance. We're only issuing guidance for the December quarter, today. We expect 3rd quarter revenue to be in the range of $20.5m to $21.5m. We expect net income per share to be in the range of $0.01 to $0.02 per share. This is the conclusion of our guidance. We plan to provide further guidance at the end of each quarter in our succeeding conference calls. We do not plan to and disclaim any obligation to provide updates to this information, even though our expectations may change during the quarter.

Now Anil and I will take your questions. Pat, would you go ahead, please?

Ladies and gentlemen, if you have a question at this time, just press *, then 1 on your touchtone phone. You will hear a tone indicating you've been placed in queue. You can remove yourself from queue at any time, by pressing the # key. But if you're using a speakerphone, please pick up the handset before pressing the numbers. Now, once again, if you have a question at this time, just press *1.

And we do have our first question from the line of Eric Martinuzzi of Craig-Hallum. Please go ahead.

Good afternoon, ladies and gentlemen. I have a question regarding your financial vertical. Just tracking financial vertical is something that I do, because it's one of your key industry segments. I've seen it decline as a percent of revenue over the past few quarters. I'm wondering - do you see that recovering any time in the near term? Of course, it has been offset a little bit by, I think, growth in government. But just strictly focusing on the financial, what are your expectations, there?

Well, Eric over a long period of time, our share from financials has varied from the low 30s where this quarter and last quarter were up to as high as 50 percent. While we continue to see strong business from the financial sector, we don't expect it to immediately rebound up to the high 50s, where it has occasionally been. We regard the broadening of our products' revenue to other sectors as a very healthy sign - particularly our penetration into government, as you pointed out.

As any sector, the financial services go through cycles. We have a very strong customer base in financial services with some very large companies, that occasionally drive our [inaudible]. When that happens, then that percentage will tick up into the 40s, again. But we don't think there's any issue with financial services being down in the 30s.

Okay.

Was that clear enough?

Yes. Secondly, you talked about - hinted at a new initiative to come out during this quarter. I'm trying to project the impact that might have on the finances of the company. Obviously, the big initiative over the past year has been the introduction of the CDM technology. I'm wondering is this next announcement more of an evolutionary - sort of a bolt-on to that? Or is it something - a separate initiative outside of CDM?

No. I think, Eric, this will be announced as part of CDM. We announced basically two phases. CDM 1 was single-[inaudible] performance management application, from a single vendor and single product. That was about 18 months ago. Then last year, we announced CDM2, which was a single out box from the wire. You don't need to deploy separate devices for management devices [inaudible]. The main performance management [inaudible] security. This is the next level of improvement in the CDM direction, only. But we're seeing it would be bigger impact than the other two. But we're not ready to announce and talk about the impact, at this point.

Yes. Okay. Fair enough. Then my last question had to do with your announcement during the quarter, that the relationship with Cisco would be ending as of November, I believe, and sort of tapering off. The impact, there. Their contribution to your business. I'm curious to know... You currently, at least for the most-recent quarter, reported about $439,000 of license and royalty revenue. Is that to say that over time, that license and royalty number will attenuate down to zero? Or just that you'll be selling it direct, as opposed to having Cisco selling it on your behalf?

The answer to that is "yes." The royalty - Cisco will, as we said in our announcement, stop reselling our product. It's a version of Performance Manager that we call RTM. It doesn't have all the functionality of Performance Manager. They will stop selling that over the next quarter - during the current quarter.

We will still see royalty revenue flow, because they report their royalties to us in arrears. So we will still royalty flow through our March quarter, but after that, the royalty flow from Cisco will go to zero.

The second part of your question was, "Will we be selling direct?" The answer is, "We will." Those customers that Cisco has sold our RTM product to who are looking for a migration path - Cisco has referenced them to us to buy Performance Manager. Performance Manager is more fully functional. It has all the advanced recording features that we've implemented, as well as the rollout coverage devices that we've recently implemented. RTM does not have all of that.

We will be selling into the Cisco customer base, RTM licenses. We get a substantially greater revenue from selling - I said RTM licenses - I should have said TM licenses. Excuse me. We get a substantially greater revenue flow from selling TM than we do from RTM royalties from Cisco.

We will not be covering the same customer base, because not all customers that Cisco has sold RTM to actually implemented. They sold it as a bundle of products, and some implement and some don't. We will not be selling to all of those customers. But we only need to sell to a small fraction of them to more than make up for the royalties that Cisco has been paying us. We think that that's a greater opportunity to go reach out to those customers, and not just sell them TM - but sell them more of a broader product line, as well.

And that would be recorded in the product line?

Yes. It will.

Okay.

I think that's one thing to add to that. While Cisco has slowly stopped selling our product directly, our product set does much more for the Cisco infrastructure than it did before. So the usefulness of our product for Cisco customers is much more than it was when they were actually selling our product.

Thank you.

Our next question comes from the line of Joe Craigen with Needham & Company.

Thank you. Good afternoon.

Good afternoon, Joe.

Hey, just to follow up on that last question, first of all, in terms of going after the install base of Cisco customers. What level of interaction have you historically had with those customers, and is there any specific plan to go after them, now.

Well, we have had relatively limited interaction with Cisco customers on a programmatic basis. We have had interaction with the Cisco sales force, historically, at the field level. Going forward, Cisco has, as I mentioned, referenced that for follow-on functionality. NetScout's Performance Manager is the most highly functional product that Cisco customers can use. We expect to be able to follow up on that reference. Specific programmatic details, we can't talk about - whether there will be major programs or minor programs that we implement with Cisco.

Okay. Just a few other things, I guess, to start off with from a high level. What's going on competitively? In particular, with Sniffer or Network General, now? Just what's going on competitively?

I think at this point, we have not seen any change that Network General formally created. But in the future, we see there is potentially more competition. At the same time, we also see a bigger opportunity because of the greater awareness of what we do. Because their product is the closest to what we do, and we were single-handedly left to marketing that. So we think the overall effect will be positive, even though the competition might increase.

Okay. A little bit more specifically, just what does the pricing environment look like? Just the ability to raise prices?

We still see our challenge is still convincing the customers why they need our product. Once they get convinced, pricing is usually not an issue. Overall, our pricing is lower than [inaudible]

In terms of when you mentioned earlier on about just the overall IT spending environment - has that played into pricing, at all?

No, it really hasn't. The comment that Anil made about in the competitive dimension applies here, as well. Every customer wants to be sure that they've gotten the best deal they can get. That goes without saying. But once customers have decided to implement our product, it is not typically an issue of, "I've got to get 5 more points of price out of the bet." We've do negotiate with customers over price. But it's not worse because of IT spending constraints. Nor are we changing our discounting policy because of that. We haven't done anything differently, even though spending hasn't...

And it's not as if IT spending is worse. IT spending is better than it was a year ago and better than it was a quarter ago. It's just not growing as fast as we - as some - had predicted, and as we had hoped.

I think there's one more thing to add, even though we have not changed our prices. But we are delivering a lot more value for the same price in the form of PM. CDM's goal, is in reducing the number of products either NetScout or competitors in a given customer environment. Some of the good feedback or validation at the user forum was that we have actually achieved that. The cost of the overall solution for them is actually less than before. Even though we'll not decrease the price of additional products.

Okay. Thank you.

Yes.

You're welcome.

And our next question comes from the line of James Cappello, with Kern Capital. Please go ahead.

Good afternoon, guys.

Good afternoon.

Why was the service revenue down sequentially?

That's more a factor of what happened in the June quarter than what happened in the September quarter. Our service revenues, you would assume, are pretty smooth. That is generally the case. However, we do have large customers with whom we negotiate maintenance renewals - particularly when they get very, very large install bases of our products. Those negotiations sometimes extend past the renewal date. When that happens, of course, we continue to support those customers in good faith. As we negotiate the terms of those renewals, then when the purchase order comes in or the renewal is agreed, we backdate, in effect, the start of that, to cover the total renewal period - the original renewal period.

When that happens, we do get a bump in service revenue in the quarter in which the renewal is negotiated, when the purchase order arrived. That's what happened in June. So we had - and I think we talked about it at the time, actually. We had an up tick in service revenue in June, which didn't reoccur in September.

Those are sort of cyclical. Our heavy renewal period is around the first of the year. If any of those renewals get delayed, they typically get delayed into the June quarter. That causes the service revenue to sort of flip up in the June quarter. So it's really a June quarter phenomenon - seasonality phenomenon. Not anything else.

Okay. And the gross margin was down sequentially, but license or product revenue was up. Can you explain why the [inaudible] on that?

Sure. Those two things are directly related. We get, because of the hardware component that's a major part of our product revenue - the probes - we get somewhat lower gross margins on product than we do on service. Our service revenue gross margins are driven by not just phone support for which we have a phone support department and a reasonably stable cost of service - but also driven by the upgrades to the software portion of our product line, that are inherent in that service. So because of that upgrade, one way to look at that service revenue and service gross margin is that customers are paying us through the service line for the new functionality that Anil mentioned a moment ago that we deliver to them if they have a maintenance contract. So they're paying us for upgrades in the service line. That gives us pretty high service gross margins - higher than product.

So that's software that is not free with maintenance?

No, it's software that is free with maintenance. But my point is that because they value the upgrade, the new functionality, they pay - our service margins are very high. They have a component of software margins to that. Is that not clear?

That's clear.

So, because of that, when product revenue grows in the mix, margins - the gross margins suffer.

Okay.

And the good news is, we're growing product. Without growth in product revenue, obviously, we don't ultimately have growth in the business. So growth in product revenue will shift the mix fro more service to less service and more product, and that will cause pressure on gross margins. It is for that reason that we've maintained our gross margin target range of 72-75 that we talk about every quarter. Because as growth returns, we expect gross margins to return to that target margin level.

Okay. And 36 percent of revenue was direct versus 50 percent sequentially. What was the driver of this change in the international government channel business? Was there lumpiness there? A couple of big orders?

Well, one of the drivers in the federal space is I guess over the long-term, we've bee putting emphasis on the federal business. We've been investing more resources, redirecting our sales resources to the federal business - and we're showing some of the benefits of that. Secondly, the September quarter's the end of the government's fiscal year. Although I don't think we would point to a huge amount of budget flush out of the federal government, it is a strong quarter. So those two factors have driven the federal business.

Internationally, we continue to increase our penetration in Asia, although we had growth in Europe, as well, this quarter. And as we do that, most of Asia and Europe are totally - as is the federal business - totally channeled. Almost 100 percent channeled. So as those segments of the business grow, then that will drive the channel number higher. That's a major portion of what happened in the quarter.

Okay. And what percent of revenue came from new customers? You added 31 in the quarter.

15.

15 percent from new customers. That's higher than we've seen in the last couple quarters, which is a good sign.

Can you point to anyone in the verticals you mentioned earlier? Financial, government, health and medical?

For new customers?

Well just in general, which ones really came on stronger than expected? Any of them weaker than expected?

Well, I think we sort of talked about the financial vertical and the government vertical. Those were the two biggest. I think health and medical, which was next, was a good sign. Obviously in today's economy, those 3 verticals are verticals which have been strong, as others may not have been. Seeing that the health and medical vertical for us has improved is, again, a good sign.

I don't know what else I might add to that.

I think that we just wanted to add a better size of our business and an amount of business in new customers, as well as a longer sales cycle we have - which is multiple quarters. I think it's not to view this as a trend - any trend, at all. New customer business is, I think, because of financial or something. These are more anomalies or one-time events. That's why we don't report further breakdown of the new customers. I just don't want you to interpret any trend from the information we just provided.

Okay. Thank you very much.

Thank you.

And once again, ladies and gentlemen, if there are additional questions, just press *1 at this time. Now we do have our last question in queue at this time from the line of Jeff Myers with Intrepid Capital. Please go ahead.

Thank you. You mentioned, I guess, federal government and wireless service providers. I didn't catch the percentage of revenue from each of those.

Well, we didn't give the wireless. Federal government was 21 percent. We did mention, and so we'll sort of stick to that discussion vehicle, telecommunications - which is principally for us in this quarter, the wireless service providers -- was a significant sector for us. What we mean when we say that is that it's close to 10 percent; it wasn't quite 10 percent, but close to 10 percent. The only sectors we ever mention are those that are generally close to 10 percent sectors.

What would you say when you go in to a customer and you're discussing selling new products to them. What's the biggest impediment that you find? And has that changed versus last year, let's say?

I think really it's not the change at that point. I think it's probably a more positive change because of technology. That's why we're doing better than last year. But I think overall challenges at the cost of doing business is going high for everyone - in non-IT areas, and sometimes that puts pressure on IT budgets. Especially with large accounts. So you have to continue to justify the value of what we provide - which is visibility for better operations. So we don't hear any change from last year, in fact, because of the increased value we are providing. We see a little bit less pressure this year.

Are you guys seeing any help from Voice Over IP? Or is it too early for that and it wouldn't help your business?

I think that is not of interest in our product for voice over IP. We are working with a couple of partners, and we have made a lot of enhancements, and we've started working on our strategy - how to get [inaudible] on that. But a lot of people do appreciate what we do, and helping the voice over IP at the moment for us is...

I see. Would you say just looking at sort of the general business environment out there, is it still pretty early in voice over IP?

I think we could see some impact of that on our business in the coming year. And so it's not early in the deployment. Maybe management is a little bit after the [inaudible] deployment. So I don't know, David - anything you want to add?

I think what we have seen in the past with voice over IP is big push by big players. What the large enterprises have done is centrally-campused deployments. Not wide area or enterprise-wide deployments. The thing that's beginning to happen now in the marketplace is, we're starting to hear people talking about doing enterprise-wide deployments. That's where the most network sensitivity comes. So we expect that that voice over IP will be a driver of our business. But we don't expect it to be a unitary driver. That is, many people - most enterprises - will not buy our product solely because they're doing a voice over IP implementation. They will buy it for general performance management, which now is much more important to them, because they're doing voice over IP.

Gotcha. Okay. Great. Thanks a lot, guys.

Thank you.

Okay.

We do have two additional questions in queue. First, a follow-up question from the line of Joe Craigen with Needham and Company.

Thank you. I want to follow up with some things on the expenses side. First of all, in R&D, what was the reason for the decrease, sequentially? Is that a...?

Well, we haven't stopped working. The decrease of a few hundred thousand dollars was sort of driven by some seasonal anomalies. They're kind of uninteresting, but they are... Typically at this time of year, we start to drop off of FICA.

Okay.

And in the summertime, people take all that vacation that they had saved up that they didn't take in the spring. That also sometimes is driven by release cycles - particularly in engineering. So what happened in engineering were those two factors. A lot of people took vacation in August, which was a good thing. Now they're all rested and back to work. So, nothing more...

It's nothing in personnel?

No. Nothing personnel-related. Nothing more significant than that.

All right. Actually, on the personnel front in sales and marketing, I think we talked previously about hiring a few more sales people. Just where do you stand with that?

Well, we have been making progress, but it's been slow progress, because we're trying to be very selective. So we still have a way to go. We have 47 quota-carrying sales reps, exclusive of channel sales and inside sales - 47 direct quota-carrying reps onboard, as of the end of September - and we're still hiring.

Okay. Thank you.

Thank you.

And our final question - a follow-up question from the line of James Cappello with Kern Capital. Please go ahead.

Yes. Just two follow-ups. What have you been seeing out of the Sniffer groups since they've broken off and been acquired by a venture cap firm?

Well so far, we have other than a new website and some announcement, we are really not seeing any difference in the vertical landscape, or anything plus or minus, in recent months. So I don't know; David?

There has been a trend that we've commented on in the last couple conference calls that we are still seeing. That is, large customers who have been pretty much focused on the Sniffer product line have expressed interest in our product. We are getting what in some places you call "design wins," with large accounts and small accounts that have been pretty much dedicated to the Sniffer product. That, in part, because of the confusion that necessarily goes on when something like this happens to an organization like Sniffer - now Network General.

We've deliberately gone after those kinds of accounts, to try to show them the value of our product, and we've announced an initiative to allow customers to integrate their legacy products - Sniffer Products - with our nGenius solution. So we are seeing some customers take advantage of that. So that's as Anil said earlier. Network General is a good company, and they're going to come back into the marketplace strongly. And they're probably already starting.

Okay. And finally, I missed the percent of revenue from Cisco.

Two percent. Very small. I think it's two.

Okay. Great. Thanks.

Thank you.

At this time, we have no additional questions in queue. Please continue.

Okay. Well, thank you all very much for attending our 2nd quarter conference call. We appreciate your questions, and we will see you at the next conference call in January.

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