Netscout Systems Inc (NTCT) 2008 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to NetScout's Third Quarter of Fiscal Year 2008 Operating Results Conference Call. (OPERATOR INSTRUCTIONS) With us today is NetScout's President and CEO, Mr. Anil Singhal. He is accompanied by NetScout's Chief Financial Officer, Mr. David Sommers. Also with Mr. Singhal is NetScout's Director of Investor Relations, Ms. Cathy Taylor. At this time, I will turn the call over to Ms. Taylor to provide the opening remarks. Ms. Taylor, please proceed.

Thank you, and good afternoon, everyone. Welcome to NetScout's Third Quarter Fiscal Year 2008 Conference Call for the period ended December 31, 2007. In terms of the format of this call, Anil will begin with an overview of our financial and operating results, and David will follow with a review of our financial results and company performance in greater detail. At the conclusion, there will be an opportunity for questions and answers.

Before we begin, however, let me remind you that 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. Such statements are forward-looking statements made pursuant to the Safe Harbor provisions of Section 21E of the Securities Exchange Act of 1934 and other federal securities laws. These forward-looking statements may involve judgment and that individual judgments may vary. Forward-looking statements include expressed or implied statements regarding future economic and market conditions, our guidance for the first quarter of 2008 and fiscal year 2009, and our continued integration of Network General. Actual results may -- could differ materially from the forward-looking statements. Risks and uncertainties which could cause actual results to differ include the company's ability to integrate the Network General acquisition successfully, as well as other factors related to the acquisition generally, the company's revenues, profitability and growth, and 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 inform you when they do. Our company policy is to provide guidance only at certain points in the year, which is 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 make today are still valid. For the further discussions of the risks and uncertainties that can cause our projections not to be achieved include the specific risk and uncertainties that are discussed in NetScout's Form 10-K for the year ended March 31, 2007 and our quarterly report on Form 10-Q for the quarter ended September 30, 2007, on file with the Securities and Exchange Commission.

I will now turn the call back over to Anil Singhal, our Chief Executive Officer.

Thank you, Cathy. We are pleased to be reporting good results for the third quarter following our recent acquisition of Network General. The deal closed on November 1, and we booked two months of revenue for Network General in the quarter. We are happy to report that both companies have solid organic growth, especially in product revenue. We acquired Network General at the time when they were at a positive inflection point with revenue growing from the newer product line, InfiniStream. This new and growing product line was the basis of our interest in acquiring Network General.

NetScout has now more than doubled its size, with GAAP revenue coming in at $53.7 million, up 103% over the same period last year. On a non-GAAP basis, revenue was $60 million in the quarter, up 127% year-over-year. Non-GAAP revenue excludes the effects of purchase accounting representing the fair value of Network General's deferred revenue.

Starting this quarter, we'll be reporting GAAP and non-GAAP measures in order to provide a better understanding of NetScout's financial performance, business trends and prospects for the future. We believe that presenting GAAP [measures] on their own would not reflect our core operating results. A reconciliation between GAAP and non-GAAP results is included in the financial [papers] in the press release.

On the bottom line, we posted a loss on a GAAP basis as a result of the acquisition of Network General. The GAAP net loss was $3.1 million, or a net loss of $0.09 per share. However, on a non-GAAP basis, we posted net income of $6.2 million, or $0.17 per diluted share. In addition, non-GAAP income from operations was $12.6 million. Non-GAAP net income and income from operation excludes the effect of purchase accounting representing the fair value of Network General's deferred revenue, share-based compensation expenses, amortization of acquired intangible assets, and inventory fair value adjustment and integration expenses.

We ended the quarter with a strength -- a strong cash position with cash and cash equivalents balance of $82 million. During the quarter, we used approximately $56 million of cash for the acquisition of Network General, which include estimated transaction costs of [the bill]. We are confident that cash flows from operations will be sufficient to repay the additional debt we incurred as a result of the acquisition of Network General.

With $80 million in cash, we effectively have only $18 million in net debt. On December 21, we refinanced the original seller's debt at favorable terms that provide us with significantly lower interest rates that decline over time as the loan is paid out, and (inaudible) including the flexibility to make accelerated prepayments as our future operating cash flow warrants. This was done with a consortium of banks that gave us good rates based upon the strength of our financials and of our prospects for future growth. We are pleased to report that the refinancing was significantly oversubscribed, despite the recent turmoil in the credit market. We intend to diligently pay down this debt as more cash flow warrants. In addition, we chose to refinance the debt instead of issuing more equity in order to avoid dilution to our stockholders and to continue our goal to drive earnings-per-share growth.

I am very pleased to report that the integration with Network General has progressed smoothly. We had laid out an integration strategy before the closing of the deal so that we could begin synergies immediately following November 1. That's why we have accomplished the majority of the synergies of approximately $30 million. We still have more integration work to do, and we expect to achieve additional cost synergies from the integration of manufacturing operations during the fiscal year 2009.

One of our biggest challenges is the integration of the two accomplished sales teams which (inaudible) at the beginning of fiscal year 2009. In conjunction with that change, they will provide our customers with a unified product portfolio and shortly thereafter, we'll introduce an integrated solution set, combining the best technologies from NetScout and Network General and, in the process, substantially reducing the total cost of ownership for our customers.

We'll be rolling out a modular suite of performance management solutions that are intended to protect our customers' existing product investments and deliver on our promise to our customers to provide them with the most advanced technologies and cost-effective solutions in the marketplace.

However, we recognize that the integration of two companies that are similar in size always presents challenges, and we are anticipating some disruption in (inaudible) business as the quarter (inaudible). The guidance that David will be sharing with you today is for the fourth quarter of the current fiscal year and for the full fiscal year 2009 and recognizes those challenges.

In addition, we are cognizant of the macroeconomic challenges that are in the news daily about the potential for an economic slowdown and that some companies are concerned about slowdown in the financial sector resulting from the credit crisis. Thus far, NetScout has not seen a slowdown in revenue from our financial services customers. Our products are being deployed in areas such as high-speed trading (inaudible). Their banks are currently expanding their use of technology. However, our outlook recognizes these logistical and (inaudible) challenges that we expect to face in fiscal 2009.

In summary, the acquisition of Network General has been an historic event for NetScout, paving the way for mainstreaming of our unique approach to assuring the consistency of IT services in increasingly network-centric business (inaudible) applications of our combined product portfolio are based on dedicated (inaudible) instrumentation, offers unparalleled (inaudible) and diagnostic power in the increasingly (inaudible) high-end IT environment. Our joint customers have (inaudible) endorsed our vision and plans and have continued to invest in (inaudible) solutions. The combined team is energized by the vision which is supported by our customers, investors and analysts, and is working hard to implement our integration plan and prepare for the challenges of fiscal 2009.

Thank you, everyone, for your support, and we look forward sharing of our accomplishments in the coming quarter -- quarters.

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

Thank you very much, Anil.

Our quarterly financial results are in the financial statements, which are part of our earnings press release.

Starting this quarter, we are now reporting our results not only on a GAAP basis, but also on a non-GAAP basis. We will be removing the GAAP purchase accounting effects of our acquisition of Network General by adding back revenue related to deferred revenue revaluation and removing the cost and expense of various acquisition-related items. In addition, we will remove the GAAP effects of stock-based compensation, which will be driven principally by the acquisition going forward. I will give you some specifics about the difference between our GAAP and non-GAAP earnings as I discuss our results.

The adjustments to GAAP revenue, cost and expense are disclosed in a reconciliation table in the financial tables attached to the press release. We believe these adjusted financial measures will enhance your overall understanding of our current financial performance and our prospects for the future. We use these adjusted financial measures internally for the purpose of analyzing and managing, forecasting our business.

Our third quarter GAAP revenue was $53.7 million, up 103% year-over-year, resulting partly from two months of Network General revenue and partly from NetScout organic growth. Non-GAAP revenue was $60 million. Non-GAAP revenue excludes a $6.3 million purchase accounting adjustment to record at fair value the acquired Network General deferred revenue.

Product revenue on a GAAP basis was $36.1 million, up 120% year-over-year. Because the third quarter includes two months of Network General results, it is not fully representative of the impact of the acquisition when compared to NetScout's prior stand-alone quarters. For the same reason, the third quarter will not be fully comparable to NetScout's quarters going forward. The good revenue results for the quarter and the bookings performance that drives revenue are indicative of initial success in minimizing sales impact from the acquisition and integration process. However, we are cautious about future integration impacts on revenue, as I will discuss further.

The GAAP net loss for the quarter was $3.1 million, or a net loss per share of $0.09. GAAP loss from operations was $2.4 million. On a non-GAAP basis, net income was $6.2 million, or $0.17 per diluted share. The following items are adjustments to arrive at the non-GAAP net income calculation. The purchase accounting adjustment to record at fair value the acquired Network General deferred revenue of $6.3 million was added back to GAAP revenue. Amortization of acquired intangibles of $1.1 million, which was principally from the Network General acquisition with a minor amount of intangible amortization raining from the acquisition of Quantiva assets, was removed from GAAP cost and expense. An inventory fair value adjustment of $1.3 million, resulting from the upward revaluation of Network General inventory, was removed from GAAP cost. Non-recurring integration expense of $6 million was removed from GAAP expenses. These integration expenses consist of $2.2 million of severance, $3 million of outside consulting for integration planning and execution support, and $821,000 of office lease restructuring, interim employee retention and other non-recurring expenses. The share-based -- and share-based compensation expense of $343,000 was removed. The total of non-GAAP adjustments to pre-tax income was $15 million. To calculate non-GAAP net income, we've used the statutory tax rate of 38% to tax effect the $15 million total non-GAAP adjustment amount, removing $5.7 million from non-GAAP net income. These adjustments are summarized in the reconciliation table included with our press release financial statements, as I mentioned.

Our GAAP gross profit for the quarter was $38.1 million. GAAP gross margin was 71% in the quarter. On a non-GAAP basis, gross profit was $46.9 million, and non-GAAP gross margin was 78%.

We made the following adjustments to non-GAAP gross profit -- $6.3 million was added back to revenue; we removed $17,000 of share-based compensation expense; $768,000 of amortization of acquired intangibles; $1.3 million of inventory fair value adjustment; and $438,000 of non-recurring integration expenses.

GAAP loss from operations was $2.4 million. Non-GAAP income from operations was $12.6 million.

We made the following adjustments to non-GAAP income from operations -- the same $6.3 million was added back for revenue; we removed $343,000 of share-based compensation expense; $1.1 million of amortization of acquired intangible assets; $1.3 million of inventory fair value adjustment; and $6 million of non-recurring expenses.

As with revenue, due to the transient effects on cost and expense of the inclusion of two months of Network General operating expenses in our gross profit and operating profit results, our non-GAAP profit results will not be fully comparable with future quarters.

Turning now to key balance sheet measures, cash and marketable securities were $81.9 million, down from $108.9 million in the previous quarter. During the quarter, approximately $56 million for the acquisition of Network General -- we used, I should say, approximately $56 million for the acquisition of Network General, and we acquired $26 million of cash from Network General. Factoring out the effects of the acquisition transaction, our cash and marketable securities grew $3 million in the quarter.

Accounts receivable, net of allowances, were $48.5 million, compared to $18.7 million last quarter. Days sales outstanding were 69 days for the quarter based on GAAP revenue. Using non-GAAP revenue, DSO were 63 days. This is up from 58 days in the prior quarter. Because of the acquisition and the increasing international component of our revenue, we're increasing our DSO target range by 5 days to 50 to 60 days.

Inventories were $10.2 million, up from $4.6 million in the prior quarter, due principally to the increasing complexity of managing multiple product lines across multiple manufacturing organizations and locations.

We are working now on the integration of the InfiniStream product line into our Westford manufacturing operation. That integration will take place during the first half of fiscal 2009 and will allow us to reduce inventory levels in relation to revenue and improve manufacturing margins over the course of the year.

Turning now to other financial metrics, revenue contribution from direct customers was 40%. Reseller revenue made up the balance. Revenue for international sales was 29% of total revenue, with Europe, Middle East and Africa at 19 points, Asia at 6 points. Americas outside the U.S. was 4 points. The strength in EMEA is driven by our increasing penetration of the wireless service provider market outside the U.S.

With the Network General acquisition, the number of new customers has increased significantly, principally due to the portable Sniffer business, which has a large number of small customers. Because that business is significantly different than NetScout's principally large customers business, and because we now have a much large customer base, we will not be discussing new customer additions as we have in the past.

We saw a significant increase in large deals in the quarter. 137 customers gave us orders over $100,000, including 26 customers with orders over [$500] and 12 orders over $1 million. Five of the million-dollar deals came from customers in the financial services industry, including two commercial banks, two investment banks and a trading exchange. Four of the million-dollar deals came from customers in the telecom industry, specifically wireless service providers. With the acquisition, we now have all of the top five U.S. wireless carriers as customers.

We also saw a million-dollar deal from a wireless service provider in Nigeria, which has deployed a sophisticated 3.5G network that is offering video calls. This is a significant new penetration into the African market, which is indicative of the potential for expansion of our wireless business around the globe.

Summarizing our business by vertical market this quarter, we had strong bookings coming from the telecom sector, representing 28% of dollar order volume, which is an all-time high for the sector. These large orders coming in from -- the large orders coming in from this sector has skewed our other vertical markets downward. As a result, we had 27% of orders coming from the financial services sector, which is traditionally greater than 30%, and we saw 12% coming from the government sector. The high-tech and medical vertical sectors followed with 6% each.

As a result of the acquisition of Network General, we now have 823 employees. This is up from 378 employees prior to the acquisition in the September quarter.

At the end of December, we had achieved the majority of the cost and expense synergies, largely through headcount reductions that we had planned at the close of the acquisition. The financial impact of these changes and of the marketing programs and facilities reductions that we are making will phase in over the next few quarters, but they have begun to show results. There were approximately $2 million of savings in the third quarter. When all synergy implementation is complete, we expect to have fully achieved our plan of $32 million of annualized savings.

And now to guidance. As Anil mentioned earlier, we are issuing guidance today for the fourth quarter of fiscal year 2008 as well as the full fiscal year -- full year of fiscal year 2009. Our guidance for the fourth quarter includes a full quarter of revenue and expenses for Network General. We expect the fourth quarter revenue results to be slightly higher than the third quarter, although dampened as Network General's sales force transitions into its former fiscal first quarter, traditionally the weakest quarter. Previously, Network General's fiscal and quota year had ended on January 31.

For the fourth fiscal quarter of 2008, we expect GAAP revenue to be in the range of $54 to $58 million and GAAP net loss per share to be in the range of $0.18 to $0.22. On a non-GAAP basis, we expect revenue to be in the range of $60 to $64 million and non-GAAP earnings per diluted share to be in the range of $0.04 to $0.08.

The fourth quarter of fiscal 2008 non-GAAP revenue and earnings estimates exclude a purchase accounting adjustment to fair value of approximately $6.3 million of Network General's deferred revenue, amortization of acquired intangible assets of approximately $1.8 million, integration expenses of approximately $5.4 million and share-based compensation expenses of approximately $1.3 million.

Now to the outlook for fiscal 2009. Our revenue guidance for fiscal 2009 recognizes the logistic and market challenges we are facing as we continue the integration process. We are planning to combine and reorganize our sales force early in the new fiscal year. In addition, we will be introducing new integrated products to the market early in the fiscal year, and we are taking into account a normal customer lag in new product adoption as we make the product transitions.

For the fiscal year, we expect GAAP revenue to be in the range of $250 million to $260 million and GAAP earnings per diluted share to be in the range of $0.08 to $0.18. On a non-GAAP basis, we expect non-GAAP revenue to be in the range of $260 to $270 million and non-GAAP earnings per diluted share to be in the range of $0.50 to $0.60.

The fiscal year of 2009 non-GAAP revenue and earnings estimate exclude a purchase accounting adjustment to fair value of approximately $11.2 million of Network General's deferred revenue, amortization of acquired intangible assets of approximately $6 million, integration expenses of approximately $1.5 million, and share-based compensation expenses of approximately $6.9 million.

We are also announcing a change to our practice of issuing quarterly guidance, effective in fiscal 2009, which is a new practice being adopted by other companies as well. We will be issuing only annual guidance going forward. In each successive quarter, we expect to comment on the full-year guidance. However, we will not give guidance for individual quarters. We are making this change because we believe that the excessive focus on short-term results distracts management and investor attention from more important long-term trends, risks and opportunities. With our increased scale and market presence, we will be focusing more strategically on those long-term issues while we continue to manage our business internally to appropriate short-term milestones and financial targets.

That concludes our financial discussion this afternoon. Thank you for joining us, and we look forward to taking your questions. Vanessa, would you go ahead please?

Yes, sir. (OPERATOR INSTRUCTIONS) Your first question comes from the line of Eric Martinuzzi from Craig-Hallum.

(Inaudible) fiscal '09, you're at $250 to $260 million non-GAAP on the revenue, and that's up from your prior forecast -- the doubling of the run rate from September '07 which implied, I think, around $237 million, if I'm not mistaken. Could you address what the drivers are on the upward revision?

Eric, it's David. We didn't hear the first part of your question, but I think it was that we've gone from doubling of revenue of about $30 million, which could be -- or 30, $29.6 million -- spread across the fiscal year, which could be interpreted as 20 -- as $237 -- up to $250 to $260. So forgive me if that's redundant, but I --

No, that's correct.

Okay. When we gave the guidance which we gave last September, we had a view of what the impact of the integration expense -- the integration process -- would be, that, as we have gone through the integration process since then -- or the acquisition and integration process since then -- we have refined, and the $250 to $260 on a GAAP basis is a modest increase because we have seen a good response from customers, as Anil mentioned, and so we have moderated slightly our caution about the dampening effects that we still expect to see in -- as we integrate sales force and reassure customers of our investment protection of their existing installations. So it's really we, in our view, are consistent with what we said -- a slight upward modification. Anil?

Yes, I think overall, like I think David said, that we see, I guess -- we were more conservative on the disruption side, but as we're getting customer feedback and as we did close a very good quarter, we are feeling much better about doing the numbers we just talked about.

Okay. What was the implied -- assuming we use a January close for the Network General -- what was the implied proforma organic growth for the quarter just ended?

I'm sorry. Can you rephrase that? I didn't quite understand what you're asking.

You were -- when you closed the transaction, you gave kind of a September '07 proforma number, sort of a 6-months-ended. What I was saying -- what I was asking was if we go and just look at the most recent quarter on a proforma -- that same proforma basis, what was the implied proforma organic growth rate on a non-GAAP [basis]?

Oh. I actually don't have that number here. We're not going to be -- we had not planned to be talking about the proforma -- the results -- current results against our proforma. I think it's fair to say, though -- so I don't have a specific number. However, it's fair to say that both companies saw organic growth. Both companies experienced good demand. Our organic growth from -- on the NetScout side was stronger than we had thought it might be at the beginning of the year. And I'm sorry, I don't have a specific number for you.

Okay. No, it's all good. It's in the right direction. And then one last, if I might. The gross margin, again, non-GAAP -- 78%. That's well above what I was expecting for the combined entity. Can you help us out with where that heads over time?

Sure. Well, I think you will see from the guidance for Q4 that it's going to take a dip in Q4. And that has to do with the effects we expect to see on revenue and the flow-through in Q4 versus Q3 and the flow-through of the [fixed] variable dynamic in gross margin in Q4. So if you think about two months of revenue from Network General in Q3 and three months of revenue in Q4 and a revenue run rate, on a non-GAAP basis, going up slightly, we expect to see in the short term a decline in gross margin of several points. Over the long term, however, we expect that the acquisition will enable us to continue to hit our -- or perhaps exceed -- our gross margin targets of 73 to 78% that we, NetScout, had historically had. We've mentioned that we are going to be doing this manufacturing integration which will allow us to bring the key InfiniStream product line into the NetScout manufacturing process, which we believe will improve margins going forward. But that's going to take place over the first half of fiscal 2009. So you'll see a drop in Q4 and then a -- and steady improvement over the fiscal '09.

Thanks for taking my questions.

Your next question comes from the line of Mark Kelleher from Canaccord Adams.

Had a couple questions. I might have missed this, but can you break out what Network General contributed in revenue in the quarter for those two months?

Mark, we're not going to be doing that going forward. The reason is -- so the answer is no. The reason is the businesses are increasingly being integrated and mixed, and although we could, for a short while, say, "Well, here's what the Network General product line contributed because it is still tracked separately", very soon that's going to be meaningless, so we've made the choice not to start doing that and then have to say end of quarter or so, "We can't do it anymore because it doesn't make any sense." Alright? So I apologize.

That doesn't make

I know it doesn't make it interesting, but we can't do it.

So it doesn't make sense to just kind of break it out where it was only part of the quarter?

No. I'm afraid we're not going to be able to --

And also, there is -- we are using -- we are making both the products available to NetScout customers, so it's not a true indicator of NetScout versus Network General business anyway because they have choice of two products versus one, and they probably are making a different decision they could have made in the past because of the choice. So that's another reason why it doesn't make sense.

Okay. And Network General had seasonality strength into the end of the January quarter. Is that right? And that's kind of mitigating into the next quarter?

That's correct. So their quota year ended January 31 and that, as with most technology businesses, is a strong quarter for them. Starting February 1, they entered their weak quarter, which is one of the significant mitigating factors in our outlook for Q4.

So it would be safe to assume that you got off to a good start in your first month of your March quarter from Network General? I don't want to put words in your mouth, but --

Yes. That would be a logical conclusion. Yes, Mark.

Turning over to the Sniffer, can you break that out as a percent of revenue or can you tell us some of your plans for the Sniffer product going forward?

I think the plans are -- 80% of the revenue comes from the product line which is called InfiniStream, and InfiniStream, directly or indirectly, is responsible for 80% of the revenue or higher. And that's the product --

Specifically the portable product.

Oh, you're talking about portable?

Right.

I think the product revenue in that area was sort of insignificant, but we have continued to count on the renewal stream from that product moving forward.

Yes, the portable Sniffer product and the DSS product have been -- revenue's been declining, although there are large install bases out there which we're going to continue to support and provide normal maintenance renewal and support for going forward. So the product -- as Anil said, the Sniffer and distributed Sniffer products are really not too significant in the overall revenue stream any longer.

Okay. Great. That's it. Thanks.

Your next question comes from the line of Matt Robison from Ferris, Baker Watts.

Congrats on your progress so far. Anil, did you say 18 or 80% from --

80, 80.

8-0.

yes, that's correct

How does that compare to AFMon sales?

I think it's significantly higher. Basically, there are three products. NetScout had a Probe product, which is its flagship product, which was a significant -- still is the biggest portion of revenue, and some of the Probe business was migrating to AFMon, which was a much smaller portion. But as in the case of Network General, it seems the DSS line was declining. Both those revenues, both those areas were covered by single product called InfiniStream. So InfiniStream and AFMon will be migrating into a single solution from a software point of view very soon, and basically they'll be -- continue to be Probe revenue and -- but as a result of NetScout having two products called Probe and AFMons and then Network General really having InfiniStream product because of the decline of DSS. InfiniStream revenue was significantly higher than AFMons.

And that 80% statistic is product revenue split.

Yes.

Okay. And are you -- do you guys intend to break out stock comp by expense category going forward?

Yes, yes. We will show that on the income statement so you can see how it -- which line items the stock expense applies to.

Do you care to offer it for the quarter we're talking about today?

I don't know whether we have that here or not. It doesn't look like we're prepared with that here. We might be able to get it for you before the end of the call, however.

Oh, that'd be great. How's the IT integration going? You guys have compatible information technology or are you having to do something duplicitous in that?

Well, it's -- well, we were both on Oracle in terms of the CRM system and everything, but overall, there were no big difference. Sales automation systems were different, but we'll be able to integrate a lot of -- I guess you're asking what dual (inaudible) IT, so I think it's not an easy task, but we -- I think it's going to be much simpler than in some other companies where there's a totally different system to start with.

Should we assume -- the book to bill, given what you're facing with the fiscal year and the seasonality for NG, should we assume that the book to bill was less than one for the quarter?

Well, we don't comment on forecasts -- sorry, on backlog or bookings, so we really can't answer that question directly. However, we had a good quarter. Good bookings quarter.

Plus they're not being impacted by the IT system integration.

Yes. And the -- what was -- was that 3 million -- was that the equivalent to operating cash flow or was there some -- what was -- or was it more like a free cash flow number?

The $3 million was a cash balance increase, so it's really none of those.

Can you provide operating cash flow and CapEx?

Well, we can give you CapEx and depreciation in one second. I have it here someplace. Yes, here it is. For the quarter, depreciation expense was $1.7 million, CapEx was $900,000 -- $1.7 million, $900,000 was CapEx. And you'll see -- shortly in our 10-Q, you'll see the full operating cash flow, but because of the investments that we're making, the cash flow statement -- the acquisition -- because of the acquisition -- the cash flow statement's a little unrepresentative of the increase -- a lot of puts and takes to get to the $3 million. So it's simpler for us just to focus on that.

Yes. Do you expect -- what areas do you expect to be investing in in the near term?

You're talking about overall new product and development investments or anything in particular?

No, not anything particular. Just in general.

Well, for first of all, we have a good team in place if you're talking about people, headcount, technologies, we are in very good shape. But we think a combination of two technologies, again, can be opened up new applications new areas of growth for our business, either in terms of what are the things we can do for the IT organization or in different verticals, as we talked about there is a lot of scope in wireless service providers and all those, so I think it will be leveraging many of the investments which are already in place to go after those opportunities, but really there is no big investment targeted beyond what we have done moving forward for fiscal year '09.

You mentioned your sales force integration is early in the fiscal '09?

Yes, it's going to be basically the -- our quarter year ends in March, and so integration will happen by the end of March, and after March 31, we'll have a single integrated sales force.

Okay, and -- alright. I'll let somebody else ask some questions.

Before you go, we have those stock-based comp line item numbers.

Great.

R&D was $80,000; sales and marketing $152,000; G&A $94,000 and costs $17,000. And that adds to the $343,000 that we mentioned of stock comp that we removed to get to non-GAAP.

Great. That's very helpful. Thank you.

You're welcome.

Your next question comes from the line of Peter Jacobson from Brean Murray.

Just a clarification. You said 80% of the Network General-related product revenue comes from InfiniStream. Is that correct?

Yes.

Yes. What I meant was directly or indirectly. As you know, NetScout sells AFMon product, but it's always sold with an application called Performance Manager. So similar to that, InfiniStream has other software modules attached to it, but they'll be useless it without the InfiniStream box, so InfiniStream is indirectly or directly responsible for that much of the product revenue.

So the 20% remaining -- is that associated with legacy products?

A legacy product or something -- some product which we may not put a lot of focus on. It's a combination of those.

And the 20% is expected to decline sequentially over upcoming quarters?

No, some of it will be replaced. Some of it will decline. Some of it will be replaced by other products which NetScout is planning to announce.

Okay. And so what's the mix between product and services for the Network General business, roughly?

Well, as you could see in the historical financials, it's been pretty close to a 50/50 mix historically, and as revenue grows organically as it did in both product lines, typically that makes swings more toward the product side because that's clearly what grows first. So you can assume that the product revenue was a little bit larger than the service revenue.

Okay. And earlier, I believe you said that both the traditional NetScout business and the Network General business in the quarter experienced growth, and were you referring to year-over-year growth or sequential or both?

Both.

Okay. And the $7 million in -- so -- to be saved annually associated with the 35 headcount cuts scheduled for the end of March, is that associated with the sales force integration and has any of that been completed at this point?

No, it's not really sales force-related. It's really related to the teams of interim people from Network General that we have asked to stay on to help us do the ongoing integration, but the sales force it's really the focus on them. It's really the IT systems, the financial systems, financial process and manufacturing process integration where most of those folks are. The people who are helping us out all have retention plans in place, and so the planning -- the agreements -- are all done, but the execution -- the interim process is continuing, so the execution is not yet done.

Okay. So you're still looking to accomplish that by the end of March?

Yes. In some cases, there are some people who will stay on past that for various individual specific reasons, but most of it by the end of March, yes.

Okay. I think that's all I have for now. Thank you.

Your next question comes from the line of Manny Recarey from Kaufman Brothers.

Good evening. When you talk about the annual savings of $32 million, you realize there's $2 million of that in the third quarter, you said, so to get that $32 million, you have to kind of rate that to about $8 million on a quarterly basis. So is that going to be through further headcount reductions, or can you just explain to me how you're going to get to that level of cost savings?

Well -- so the way to think about that is November 1, as Anil had mentioned, we had a plan that was in place and we started to execute it. That's, of course, one-third of the way through our December quarter. And across the course of the month of November, we notified people and reached agreement with people on interim plans, and through the month of November and into December, people began to leave as agreed. And so the savings -- synergies were realized sort of over the course of -- the initial traunch of them -- over the course of the quarter. So not -- we didn't reach a full run rate -- you won't see a full run rate visible in the quarter. You will see that run rate for everything that was done in November-December in Q4. And so that's why it wasn't -- you're right -- $8 million is a quarterly -- our quarterly target, and you can see the two-thirds of that that we say -- we have been saying we have achieved through what's actually been implemented, but you don't see two-thirds -- you don't see 60 -- $6 million or $5 million of savings yet in the synergies because of the phased implementation.

Okay. When you -- looking at the -- or comparing the guidance, you had talked about disruptions when you first made the announcement of the acquisition. Has those -- has anything changed in your outlook as far as -- with the sale integration and customers reacting to the merger and so forth? Have you seen any -- there any changes in your outlook?

Well, first of all, there was an earlier question about that we seemed to have raise the guidance, sort of -- and what you are talking about -- beyond two times of the next quarter revenue, which we talked about earlier, and that's coming from, I think, better -- much more solid support from customer base, so the customer disruption is actually less than what we had thought. In other areas -- finance, engineering, all those -- it's about the same. And in the sales area, we are expecting to be about the same as we thought, but it remains to be seen over the next couple of months as we put that into execution.

Okay. If I could just have one more question on a different matter. I saw that HP is talking about a new upgrade to their Network Node Manager and the software add-on that they're going to be introducing soon. SPI for performance. Just curious on how -- or is that going to have any impact on NetScout at all? Or just your view on that?

I don't think -- if at all, it might be a positive impact and we are not ready to announce what role we play in that, but we certainly don't see a negative impact of that. It really doesn't go after the problem we are going after, so hopefully we can share some of that with you during the next call.

Okay. Thanks.

Your next question comes from the line of Scott Zeller from Needham & Company.

Thanks. Question on sales. We've already discussed on the call that the integration of sales will take place in the March timeframe. I was wondering, though, at this point, can you give us some color where things stand with the leadership in sales, and if you had departures, are you happy with who's currently in place in senior roles for sales?

Yes. There are no -- I think basically -- we cannot talk about all the details because this has not been exposed to the people, but from the management point of the integration is going very well. We have almost everyone excited about moving forward we wanted to retain, and so I think organization and other planning is coming very well, but there is still a lot of work ahead in March in terms of quotas and things like that.

Okay. And the other question is regarding the -- we've heard a lot about the effort to tailor your offering to the wireless provider community, and we also have heard recently about the effort to do the same thing for the financial services community and the trading organizations. Could you tell us where you stand with that -- targeting the trading organizations -- because I wasn't able to tell from when we last talked about it if it was actually out and active in the field. You had a good quarter for financials. I wanted to just get an update.

Well, I think -- yes, in both cases, what is out in the field are independent offerings. So we have been offering both for the trading floor as well as wireless service providers, but they're currently sort of silo individual offerings. And in one area, there is some overlap which we need to reduce, and in other areas, we need -- those offerings are complementary and we need to combine them and integrate them. So the integration product we have -- integrated product we are talking about, which is next quarter, then following that -- is really going to fully deliver on that promise. But what we talked about -- what is already selling -- is individual products, either as a Network General offering or as a NetScout offering.

Okay. Sorry. I think I was -- I wasn't clear -- I apologize. What I really meant was I couldn't get a sense from when we spoke earlier how long the trading floor targeted offering was really being offered in the field. Has it been in place for a couple quarters now? How long have you had it active in the field?

Yes, I'd say it's like a couple of quarters, but it has been -- maybe a couple of quarters for Network General and maybe a quarter or so for NetScout, but it has really not gone into the mainstream because there was -- it was a work in progress. So we are seeing a bigger impact on that in the fiscal year '09 than we saw in '08.

Okay. That's what I was interested in. Thank you very much.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of J. D. Padgett from The Boston Company.

A couple quick ones. One, just what would be the share count we should be thinking of going forward? And the tax rate?

Hold on one sec. Share count for the quarter is at about 36.5 and that's going to go up toward about 39 as we go into Q4 because of the issuance of 6 million shares to the sellers of Network General.

Right.

So those are some -- and your other question was? Sorry.

Was just the tax rate. Looks like the non-GAAP tax rate from this last quarter was up in the mid-40%, if I was doing the math right.

I have to get some help here on that.

I just took the $12.6 million of non-GAAP EBIT --

Yes?

And subtracted the $1.2 million of interest expense, I think.

Okay.

And then you drop $6 million and change on a net basis from that?

That sounds right. So the way we're doing this is calculating our GAAP provision from our tax position and then, using the statutory 38% rate on the -- to remove things from the non-GAAP -- to calculate the tax to remove from the non-GAAP net income --

Right.

And because our GAAP provision is below 38%, that simplifying calculation -- because we're not doing a whole new GAAP -- sorry, non-GAAP tax provision calculation -- that simplifying calculation will result in high non-GAAP tax provision rates --

Okay.

Which is what you've seen.

Okay.

Now, the reason for doing that is because a non-GAAP tax provision is kind of meaningless because you don't have the underlying support of how the credits and the expenses really relate to the non-GAAP P&L. So just for simplicity's sake so that everybody can understand it, we're saying 38% on the non-GAAP adjustments and let the provision fall where it may. Is that clear?

Maybe. But for the purposes of computing non-GAAP EPS in this current quarter, for instance, of whatever you said -- $0.04 to $0.08 -- what should we be using? We come up with our estimate of non-GAAP EBIT and then some interest expense and we get non-GAAP pre-tax. What's the tax rate we should apply against that to get non-GAAP EPS?

The way to do it is to take the GAAP numbers and you'll have the provision, and you can use that provision -- you can assume that the GAAP provision is reasonably stable, and then look at the adjustments between GAAP and non-GAAP and use the 38% rate on that and see what the combined resulting rate is.

Okay. So come up with a GAAP estimate first --

That's correct.

Use the provision on that.

Right. And you can assume that, because of our GAAP tax provision methodology, as most people's area, is relatively stable. We look at an annual rate and we adjust it quarterly. So it should be -- unless something significant changes in our tax posture -- it should be relatively stable.

Okay.

Okay?

Historically, that's been what? Around 30%, right?

Yes, in the low 30's. That's right.

And that doesn't change with anything we're talking about here?

No. It will change over -- year to year, but within a year, it should be pretty stable. So that methodology we talked about should work reasonably well.

Okay. Good.

The non-GAAP provision.

And then the final question, just so save me the headache of doing the math. What would be the interest expense in a full quarter with the current financing?

Okay. Well, so we've got about $100 million of debt out, and our debt is at about 300 basis points over LIBOR, and LIBOR is around 5, a little less. So let's call it 8. So that's $8 million a year divided by 4 is about $2 million a quarter.

Okay. And then you have the interest --

That's a little high. That's a little high. But that gets you in the right ballpark.

And you have the interest income offset from the cash?

That's correct.

Okay.

Which is going to yield a lower rate --

Right.

Right.

But the cash we see at the end of the period here -- the 52 plus the 29 -- that's reflecting everything you paid out for the acquisition.

That's correct.

Okay.

And one thing I should say is we do expect, as we -- if we continue to perform as we did in Q3, and we expect to going forward -- that we will be stepping down the margin in the debt offering over time. So those interest rates, as Anil mentioned in his remarks, will be coming down.

That's because of refinancing or because you're paying it down?

Because the interest margin in the debt decreases as we pay down the debt.

Okay.

And as our leverage -- and as we increase non-GAAP EBITDA. So as that leverage ratio -- you'll see in the debt filings is that leverage ratio improves so there's less leverage so the margin goes down, and of course, whatever LIBOR does it what LIBOR does.

Great. Thanks for the explanation.

You're welcome.

At this time, there are no further questions. I will now turn the call back over to Mr. Sommers for a closing remark.

Thank you all very much for attending our third quarter earnings call. We've really appreciated the good attendance and the good questions, and we look forward to speaking with you again toward the end of April, beginning of May, at the time of our fourth quarter earnings call. Thank you and good night.

This concludes today's conference call. You may now disconnect.