Netscout Systems Inc (NTCT) 2008 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to NetScout's fourth quarter and fiscal year-end 2008 operating results conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions would 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 Chief Financial Officer, Mr. David Sommers. Also with Mr. Singhal is NetScout's Director of Investor Relations, Miss Cathy Taylor. At this time, I'll turn the call over to Miss Taylor to provide the opening remarks. Miss Taylor, please proceed.

Thank you and good afternoon everyone. Welcome to NetScout's fourth quarter fiscal year-end 2008 conference call for the period ended March 31. 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 individual judgments may vary. Forward-looking statements include expressed or implied statements regarding future economic and market conditions, our guidance for fiscal year 2009 and our continued integration of Network General. Actual results could differ materially from the forward-looking statements.

Risk 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 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 of the year such as during the quarterly earnings call. 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 could cause our projections not to be achieved include the specific risks 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 December 31, 2007 on file with the Securities and Exchange Commission. With that, I would now like to turn the call back over to Anil Singhal, our Chief Executive Officer.

Thank you, Cathy. We are extremely pleased to be reporting a very strong fourth quarter with both revenue and EPS at the high end of our guidance range. This was our fourth full quarter of combined financial results following the acquisition of Network General on November 1st.

GAAP revenues were $57.7 million more than doubling last year's fourth quarter. Non-GAAP revenues were $64 million up 134% year-over-year. Non-GAAP revenue excludes the effect of purchase accounting adjustments representing the fair value of Network General's deferred revenue.

The GAAP net loss for the quarter was $4.9 million or a net loss per share of $0.13 as a result of costs associated with the acquisition. On a non-GAAP basis, net income was $4.8 million or $0.12 per diluted share. Both of our GAAP and non-GAAP bottom-line results were above expectations due to tax provision adjustments resulting from the acquisition. Even without those tax adjustments, our GAAP and non-GAAP earnings per share would have been slightly above the high end of previously issued guidance. Non-GAAP net income excludes share based compensation expenses, amortization of acquired intangible assets and integration expenses and related income tax adjustments.

As we enter our new fiscal year, we're very happy to report that our near-term integration goals have been accomplished and we have met or exceeded all of our goals and expectations since we acquired Network General. We have recognized the majority of planned synergy savings while more than doubling our revenue run-rate..

Our HR and finance policies are in place, we realigned our sales force and the infrastructure and system integrations are complete. Our manufacturing consolidation is on plan and will be completed before year-end. The final step in our integration effort is a full integration of the sales force that was initiated on April 1.

Crowning all these accomplishments we are delighted with the continually strong order flow we're seeing since the acquisition was announced. We believe these results demonstrate our customers' strong confidence in the future of the new combined company.

Notwithstanding all of these positives, we remain cautiously optimistic about the continued strength of our orders as we enter a new fiscal year 2009. There are two potential causes for concern -- an economic slowdown and the full integration of our sales force. We anticipate that there may be some business disruption as we fully integrate our products and as our salespeople adjust to new territories and selling new products.

On the customer front we are optimistic in part because we've not seen a broad slowdown so far in the financial services sector due to the credit crisis which has been a concern by many outside of NetScout. While some customers are indicating that business would be slow our financial services business was strong last quarter and we booked 14 orders over $1 million with the top four orders coming from three large investment banks and one commercial bank. Recognizing these factors and with a very strong fourth quarter providing us with good visibility into the first quarter. We are reaffirming our guidance for the full fiscal year.

Looking ahead, our product integration plan for fiscal 2009 is in place and we are on schedule for the delivery of new products and upgrades. Our goal from the beginning has been to maintain customer satisfaction and to protect their investment throughout the integration process. Over the next few months we are on schedule to release products for the fully integrated nGenius Infinistream that will encompass the best features from the legacy nGenius AFMon and Network General's Infinistream.

In addition, we continue to release new products that have been in development prior to the acquisition. Our newest product is nGenius K2, an application services dashboard using advanced intelligence providing network operators with at-a-glance status and early warning of performance degradations. nGenius K2 represents one of the new suites of performance management products that we will be bringing to the market that support our vision of providing our customers with the most sophisticated technologies for managing their modern IP networks.

In summary, the acquisition of Network General is proving to be a watershed event for NetScout as well as our customers. We ended the 2008 fiscal year on a very positive note and we have laid a strong foundation that will allow us to grow despite some of the challenges of the fiscal year 2009. As the year unfolds, we look forward to sharing those accomplishments with all of you.

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

Thank you, Anil. Our quarterly financial results are in the financial statements which are part of our earnings press release. We are reporting our results on a GAAP basis as well as on a non-GAAP basis. To summarize, we removed the GAAP purchase accounting effects of the acquisition of Network General by adding back revenue related to deferred revenue revaluation and we have removed the cost and expense of various acquisition related items. In addition we have removed the GAAP effects of stock based compensation which is driven principally by the acquisition going forward.

I'll give you the specifics about the differences 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, managing and forecasting our business.

Our fourth quarter GAAP revenue was $57.7 million up 111% year-over-year resulting from organic growth and the first full quarter of financial results following the acquisition of Network General. Non-GAAP revenue was $64 million. Non-GAAP revenue excludes $6.4 million purchase accounting adjustment to record at fair value the acquired Network General deferred revenue.

Product revenue on a GAAP basis was $33.7 million up 96% year-over-year and down 7% sequentially. Service revenue was up 137% year-over-year and up 36% sequentially. Because the fourth quarter includes a full quarter of Network General results, it is not fully representative of the impact of the acquisition when compared to NetScout's prior quarters and should not be compared to the third quarter which includes only two months of Network General results.

The GAAP net loss for the quarter was $4.9 million or a net loss per share of $0.13. GAAP loss from operations was $9.3 million. On a non-GAAP basis, net income was $4.8 million or $0.12 per diluted share. The following items are adjustments to arrive at non-GAAP net income. Purchase accounting adjustment for recorded fair value of the acquired Network General deferred revenue of $6.4 million was added back to GAAP revenue. Amortization of acquired intangible assets of $1.6 million which was principally from the Network General acquisition was removed from GAAP cost and expense.

Nonrecurring integration expense of $6.7 million was removed from GAAP expenses as was share based compensation of $1 million. The total of non-GAAP adjustments for pretax income was $15.6 million. To calculate non-GAAP net income we've used the statutory tax rate of 38% to tax effect the $15.6 million total non-GAAP adjustment amount removing $5.9 million from non-GAAP net income. These adjustments are summarized in the reconciliation table included with our press release financial statements.

The provision for income taxes represents an effective tax rate benefit of 56% on a GAAP basis this quarter and 9% on a non-GAAP basis. The GAAP benefit rate is due to the Company's full fiscal year 2008 pretax loss position increased by the current quarter tax credits associated with tax-free interest and eligible R&D expenses. The non-GAAP benefit rate is calculated by taking previously calculated GAAP rate of 56% and tax affecting the non-GAAP adjustments at the statutory 38% as I mentioned.

Our GAAP gross profit for the quarter was $39.2 million. GAAP gross margin was 68% in the quarter. On a non-GAAP basis, gross profit was $47.3 million and non-GAAP gross margin was 74% down four points due to a higher content of lower margin Network General products in the quarter.

We made the following adjustments to non-GAAP gross profit. $6.4 million added back from revenue, we removed $70,000 of share based compensation, $1.1 million of amortization of intangible assets and $642,000 of nonrecurring integration expense. The GAAP loss from operations was $9.3 million. Non-GAAP income from operations was $6.3 million and we made the following adjustments to non-GAAP income from operations. The same $6.4 million was added back from revenue and $1 million of share based expense compensation expense was removed along with $1.6 million of amortization of intangible assets, $6.7 million of nonrecurring integration expense.

The $6.7 million of integration expense consists principally of $2.1 million for an all employee new company launch event which we held in March and $1.7 million of severance and $2.1 million of outside consulting expense. These items will not continue in Q1 and beyond.

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

We achieved our planned synergies in the fourth quarter and we're on plan for achieving the remaining synergies in the current quarter Q1. When our synergy implementation is complete, we expect to fully achieve our plan of $32 million of annualized savings. We ended the fiscal year with 790 employees.

Turning now to key balance sheet metrics. Cash, short-term and long-term marketable securities were $100.9 million up from $81.7 million in the previous quarter. The increase is due to strong cash collections during the quarter including collections of $13.5 million from product shipments that were classified as deferred revenue on the balance sheet.

Our long-term marketable securities include investments in auction rate securities valued at $33.1 million. Auction on rate securities are publicly issued securities with long-term maturities for which interest rates reset through a Dutch auction in short-term intervals; in the case of our securities every 35 days. Historically, the auction process has provided liquidity and has supported a short-term classification of these securities on the balance sheet. Beginning in February 2008, uncertainties in the credit markets resulted in failed auctions and a lack of short-term liquidity produced for these securities.

All of our auction rate securities are AAA rated and collateralized by student loans with underlying support by the federal government through the Federal Family Education Loan Program and by monoline insurance companies. We have the ability and the intent to hold these securities until a recovery in the auction process or other liquidity event occurs.

For year-end, we value these securities at a slight discount to par to reflect liquidity concerns and classify these securities as long-term on our balance sheet with a temporary decline in value reported to Other Comprehensive Loss on the balance sheet. The temporary illiquidity of these investments will have no effect on our business operations.

Accounts receivable net of allowances were $32 million compared with $48.5 million last quarter. Day sales outstanding for the quarter based on GAAP revenue were 52 days. Using non-GAAP revenue, DSOs were 47 days. This is down from 69 days in the prior quarter.

Because of the acquisition and the increasing international component of our revenue last quarter we increased our DSO target range by five days to 50 to 60 days. Our DSO of 47 days this quarter is the result of very linear shipments and collections across the quarter.

Inventories were $12.1 million up from $10.2 million in the prior quarter. Inventory levels increased primarily because the cost of the product and deferred revenue is still in our inventory. Operationally, the in-sourcing of Network General's manufacturing into NetScout's facility in Westford, Massachusetts has gone smoothly without any major impact in inventory.

Turning now to other financial metrics, revenue contribution from direct customers was 32% and reseller revenue was 68%. Revenue from international sales was 32% of total up from 29% last quarter. Europe, Middle East and Africa was 18 points, Asia was at nine points. Americas outside the US was five points.

The main drivers of international business were the wireless service provider and financial services sectors. We saw an increase in large deals this quarter. 153 customers gave us orders over $100,000 including 33 customers with orders over $500,000 and 14 orders over $1 million. Five of the $1 million deals came from customers in the financial services industry including three investment banks, one commercial bank and a trading exchange. Four of the $1 million deals came from customers in the telecom industry all wireless service providers. Three of them came from government.

Summarizing our business by vertical market this quarter, we had strong bookings coming from the financial services sector representing 32% of quarter dollar volume. The government sector was at 18%, telecom at 16%, high-tech and medical sectors followed with 7% each. And now to our guidance.

As a reminder, last quarter we announced a change to our practice of issuing quarterly guidance and effective this year fiscal 2009 we will be issuing only annual guidance. This change will allow us to focus more strategically on important long-term trends, risks and opportunities while we continue to manage our business internally to appropriate short-term milestones and financial targets. In each successive quarter we expect to comment on the full year guidance. As Anil mentioned earlier we're reaffirming our outlook for the 2009 fiscal year which remains unchanged from last quarter.

Our revenue guidance for fiscal 2009 recognizes the internal and market challenges we're facing. Starting with the June quarter, we're combining and reorganizing our sales force and we will be introducing new integrated products for the market over the upcoming quarters. We recognize these changes could cause business disruption and we're taking into account a normal customer lag and new product adoption as we make product transitions.

For fiscal 2009 then we expect GAAP revenue to be the range of $250 to $260 million and GAAP earnings per diluted share to be 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 million to $270 million and non-GAAP earnings per diluted share to be in the range of $0.50 to $0.60.

The fiscal year 2009 non-GAAP revenue and earnings estimate exclude a purchase accounting adjustment to fair value of $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 of approximately $6.9 million.

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

(OPERATOR INSTRUCTIONS) Matt Hewitt, Craig-Hallum Capital Group.

Congratulations on the strong quarter. Just looking at the gross margins, will you be able to get back to the NetScout historical range of the upper 70s and if so how quickly do you envision that occurring?

Well, a couple of factors in that. First, we have seen and will for the near future continue to see probably quarterly swings in the mix of legacy NetGen products and NetScout products as we shift mix to satisfy customer demand. That's what occurred in Q4.

But we are as we have said providing integrated products to the market that will be targeted at NetScout margins and as we continue to move the Network General manufacturing process into in-house and start to deliver those integrated products, we expect that our margins will return over the course of the next couple of quarters certainly by year-end to more like NetScout historical levels.

That's great. Given the strength you had this quarter compared to what your guidance had been at the upper end of the ranges do you think that some of that was related to customers possibly holding off a little bit when the announcement was made and then coming back here in this fourth quarter with full orders or was that just the way we should view the quarters going forward?

It's hard to know for sure. We did not see a noticeable slowdown in Q3 either that would have perhaps been visible or in fact NetGen's business or in NetScout's business prior to the close on November 1. We had anticipated there might be some and we really didn't see much. So, it's impossible to be sure but based on the aggregate information probably not.

In general our customers have been very positive, supportive. As we call on them, the sales force calls on them we're not hearing back doubts or concerns at all about the combination or about our product direction. So we're not getting a sense that there is any delay so far going on. As we mentioned in our guidance discussion, it is always possible as we bring out new products which we're going to be doing over the next quarter or two and beyond that that will cause customers to pause to wait and look at the new products. And that is not necessarily acquisition related, that's normal kind of customer inspection of new products.

Thank you and congratulations on the quarter.

Mark Kelleher, Canaccord Adams.

Thanks. I was just wondering if you could talk a little bit about the mix between product and service. It seems like service was very strong, product down sequentially. Can you just talk about that?

Sure, as you may know from some of our earlier discussions, Mark, the NetGen business had a stronger mix of service than did the NetScout business and their historical reasons for that have to do with the product cycles that NetGen's business had been in over the last several years. As we have added this quarter a full three quarters for the first time of NetGen results that strength in their basic product service mix came through.

And of course as we see very strong order results, order flows as we have talked about and as I mentioned the service that flows from them flows on a standard sort of schedule and as we build lead times on product shipments, the product orders don't necessarily flow out in the same proportion but service will because when you start a service contract the revenue automatically flows from that. So those are some of the dynamics that are affecting this. We would not expect to see going forward through fiscal '09 service regularly grow faster than product.

Peter Jacobson, Brean Murray, Carret & Co.

Good evening everybody. Just a clarification, you talked about some sales force restructuring in the June quarter. Were you referring to new and additional activities above and beyond the April 1 restructuring?

Peter, we're basically talking about not authorization changes but we were really running like parallel operations until April 1 even though we had made all the changes. So I think what we're talking about after April 1 is really having a combined truly integrated sales force with common products and new comp plans and territories. So that's what we talk when we talk about potential disruption or confusion and all those. But it's not really restructuring or elimination of people or anything like that.

So it's the impact of everything that occurred up through April 1 as opposed to new actions after April 1?

Some of the actions we have taken before April 1 were not effective until April 1 and first of all there is normal Q1 effects even in stand-alone NetScout because of new comp plans and territories -- new plans and quotas and everything. And there was additional level of I guess burden on salespeople because of new territories and really having a common price list and basically truly integrating the sales force which was not completely done even though it was announced by April 1.

So just to be clear, Peter, by restructuring we don't mean there's any more job eliminations. There have been none.

Okay so maybe could you just review a sense of percent completion as far as integration activities for sales manufacturing, product integration and other at some point time?

I think basically we talked about in a quarter or so we should have the most important portion of the product integration complete. We have in the manufacturing and sales in terms of actions we have to take we're almost there but in terms of the effect of those actions on the business is what we're talking about. So even though the actions are complete, all the decisions have been made, they have been implemented. How successful they will be in terms of keeping the disruption to a minimum like what we have been able to do in the past is what we're talking about here.

We have completed our back office integration. New procedures in place are still being understood and education is still continuing but the Oracle system went live at the beginning of April, the new integrated Oracle system. So just to try to use that perhaps as an example when we say integration effects will continue and there may be disruptions it is the education, the learnings of the combined organization and learning to work together and how we do things together as now a combined integrated company as opposed to sort of two parallel sales organization that it was prior to April 1 that we anticipate will have some lingering effects. It's not that we need to continue to change things.

I think that's one thing to add, Peter, maybe ultimately you're trying to get what is the impact of that going to be and this is not something we have - we're just mentioning it right now but it has been known from the past. That is the reason we're not changing the guidance. It's all built into the guidance, all these effects are built into the guidance we gave last quarter. Really nothing has changed in terms of potential disruption or effect of those as far as the guidance is concerned.

My sense is that the full product implementation or integration schedule seems to have moved up some from the original plans to have that completed by the end of the year. Is that a fair (multiple speakers)

I think basically we think that in the next few months, two, three months we will have I would say the most important part of the integration which is NetScout's reporting product, performance management product being able to pull data from Network General products and having a common instrumentation platform based on the AFMon and Infinistream technology. That is the majority of the product business moving forward. And that will be done within the next couple of months or so. And that is as planned and as announced internally.

And then I think my last question -- how would you describe kind of the win/loss rates now versus when Network General was your most common competitor and what kind of impact has the lack of that competitor at this stage had on pricing and sales cycles?

We have really not changed the pricing significantly. There may have been some minor changes here and there. We used to report 10 to 20% deals that were competitive in the past and I think obviously that has gone away. There are a couple of small competitors but not to the extent of 10, 20%. And we are seeing that impact in the results. That's why we have such a great fourth quarter and all, soit was not the biggest portion of the issue in the past but whatever it was I think that has reduced and there is no real new competitors who have basically a similar impact as we had. There are a lot of small competitors here and there and I think we will see some more moving forward but nothing to the extent we have before.

Matt Robison, Ferris, Baker Watts Inc.

David, what you think the service revenue percentage will be for '09? And maybe give a range of within which it will move around?

I think the range for -- we're probably going to see around 35% service, maybe 35 to 40% and it will probably fluctuate in the range of 35 -- in that range 35 to 40%. We are -- we as NetScout have seen 30 to 35% service, NetGen was heavier as I mentioned. I think the sort of the blended mix is somewhere in the around 40, maybe a little higher. As we come out with new products and start to accelerate product shipments and product revenue expect to see that fall back a little bit.

So maybe a decline from the level you just reported down towards the mid-30s over the course of the year?

Or 40 -- maybe 40 in the beginning of the year

Maybe I missed part of your explanation but why was product revenue down sequentially?

You probably didn't miss it. You probably just didn't understand my convoluted explanation. So let me try again.

NetGen had higher content of service in their revenue. In the first quarter we only had -- the third quarter, the first quarter after the acquisition we had only two months of NetGen content. So as you are thinking about a blend of above high 40s, service revenue from NetGen and low 30s service revenue from NetScout; put together 50-50 you get 40. You put together three-quarters of NetScout and two quarters of NetGen you get something in the high 30s. That is part of what drove that.

The other thing that drove that was we are now in the -- giving customers lead times for product deliveries and as we do that and are able to deliver product the service revenue which flows from new orders will flow regardless of that and product orders will flow obviously product revenue will flow obviously when we ship the product. So, one of the -- additionally one of the points is that NetGen came to us with a stronger content as part of their service revenue of consulting and training than NetScout had had in the past. That was particularly high in Q4. That's what I tried to say before. Did it make any more sense this time?

I think I understood what you said except that I don't see how it explains why the product revenue was down sequentially not just on a percentage basis but on a dollar basis.

So what I am trying to suggest here is we had strong orders and we didn't ship them all.

Okay so your book to bill was well more than one?

We don't talk about that. We're not quoted that but you can tell from the fact that we said we had strong orders and we have lead times now for product delivery that you can draw your own conclusions from that.

What was the operating cash flow in the quarter?

Good question. We will look that number up and get it right to you.

Also CapEx, so I can get to free cash flow. And the tax rate going forward?

Tax rate going forward for '09 we expect to be on a non-GAAP basis we expect to be around 34%.

What about -- and that is with the 38% on the fair value adjustment?

That's right, I gave you what those fair value numbers are (multiple speakers) so you can reverse engineer the GAAP number. So you wanted CapEx? CapEx was $2.1 million for the quarter and depreciation was also $2.1 million and free cash flow was about $30 million.

So what you were just saying about the tax rate when you talked in terms of derivation would imply that sort of whatever we get to doing that exercise would be where we would be of we were kind of doing an adjusted number without the fair value?

Didn't quite understand that. The number I gave you (multiple speakers)

Trying to figure out what the cash tax would be given that the fair value is -- if you're one of those that might view that as sort of an artifact.

Yes, we don't expect to be because all of the unwinding of NetGen's somewhat more complex international tax structure than NetScout's had and the tax effects of that on our credits and net operating losses. We don't expect to be a cash taxpayer in 2009.

Okay I will yield the floor. Thanks.

Manuel Recarey, Kaufman Bros.

Just a follow-up on the last question that orders were strong and you weren't able to shift everything out essentially. What was the reason for that? It's just that orders were strong? There's nothing on the manufacturing side or anything like that?

Yes, there's no manufacturing bottlenecks. We had a lot of things going on in manufacturing. For example we were transferring at the end of the quarter the inventory from the outsourced NetGen manufacturers to our facility. So that's we stopped shipping some NetGen products of the end of the quarter. But that was not the principal driver here. The principal driver here was that we had very, very strong orders through the quarter and we did not ship them all.

Demand is strong, that's good to hear. You mentioned you had a large number of large orders. Do you expect that to kind of continue to go forward because I guess the concern that can pop up -- is that at least on a quarterly basis you get a little lumpiness. So just kind of any comments on that?

First of all that's one of the reasons we're giving yearly guidance and I think this question has come up even in stand-alone NetScout many times as we discuss the $1 million order we feel good and bad about it at the same time. And I think we have not seen a big effect. We have -- the biggest business size we have, I think we have even less of exposure even though the number of $1 million deals have increased. So I think it's going to be there but with the guidance we have provided and the new model we're moving towards I think on a yearly basis it will look good.

Okay then the last question. You had mentioned about linearity was pretty good in the quarter. I guess you didn't see any of the kind of macro issues that others saw during the quarter?

Well that linearity comment related to DSO which related to shipments and revenue recognition and therefore invoicing and collections. One of the things that changes when you have significant visibility going into a quarter is your shipments are not typically back end loaded. They are more linear. And that's what we're seeing.

Your next question comes from the line of Rajesh Ghai from ThinkPanmure.

Congratulations on the strong upside. I wanted to ask you a little bit about the sales forces. You said they were kind of independent, the two sales forces and the two organizations. Did you see any cross selling into the Network General installed base this quarter. Is that a reason for the upside?

No, I think cross selling has not started yet because we have to integrate the two products and so right now that's not the reason. I think people are feeling very good about the combination of the two companies and investment protection aspect. So they didn't hold any orders and last quarter there is a big push because of (inaudible) everything from both sides sales forces. So we had the least amount of disruption and confusion and in a traditionally strong Q4 quarter with customers feeling pretty good about the prospects of the future.

So now that the sales integration process has begun you might see some cross selling in this (multiple speakers)

Basically it's going to be more towards the end of the year because as I just mentioned it will take two or three months to get the most important part of the integration complete and take another three or four months for people to start getting that and so it will be towards end of the year before we get into the cross selling opportunities.

One question on the guidance. Given that you reaffirmed it and you haven't raised it given the strong quarter this time around, if you look at a run rate for this quarter and you multiply before it brings you very close to the lower end of the guidance range. I'm just kind of curious as to why you have been conservative on the guidance (multiple speakers)

Yes, we want to provide upside to investors and we looked at all of those potential negative issues, disruption because of product integration, sales integration or some of the macro effects that somebody was talking about earlier. Maybe we are late in seeing that and so we want to be conservative at this point and wait and see. And we can always revise the guidance if things improve.

On the international business, you mentioned that Asia and Europe was strong on the back of some pickup in demand in the wireless sector. But then I see the telecom contribution that's only 16% and actually that's actually down from 28% in the last quarter. I'm just kind of trying to understand that dichotomy.

So wireless comes in typically in big lumps particularly in the US, right? So it's a little bit difficult to draw trends from quarter to quarter, draw conclusions. What is true in smaller -- with smaller numbers outside the US is the telecom and financial services business, the same drivers of our business inside the US, are strengthening, particularly telecom, and this has been a trend that we have been pursuing for some time to take our success inside the US with wireless carriers and translate that outside as quickly as we could.

But you can't really unfortunately draw a conclusion from the fact that a sector like wireless is up one quarter and down the next in terms of projections going forward. Those are sort of the random fluctuations (multiple speakers)

Some big orders in the last quarter in the US and places in Europe could swing that. That's what David is saying.

That's what I was thinking. And looking back on your Q2 announcement a couple of weeks back, one of those side notes on that was that your product is integrated with HP Tivoli suite -- I'm sorry -- the IBM Tivoli suite. I'm just wondering is there a partnership in the offing or just one of --?

I think we announced something more with HP and we continue to improve that. The IBM integration is nothing new. I think we had done some time ago. I don't think we made any announcement in the IBM area.

I think there was an incremental integration. We had an earlier one, we did an incremental one. But it's not -- it's just sort of a standard integration with IBM.

Any early response to the K2, any idea that you can give us right now (multiple speakers)

I think we have actually sold many copies of that and we continue to add features, the most exciting feature which I think people will be interested in especially in Network General installed base has not even really been truly sold. But we have some pent-up demand in the NetScout installed base and we are already seeing quite a bit of success there, many copies of that software already sold and being used.

One last question. So the HP partnership, any pickup on the -- any traction in this quarter? Or it is slowly (multiple speakers)

I think there's a lot of activity in meetings and things but nothing to talk about or announce right now.

Thank so much and congratulations again.

Alex Kurtz, Merriman Curhan Ford & Co.

First off could you give us a sense of how much your business last quarter came from existing or installed base customers?

I actually don't have that statistic at my fingertips but I would think it is 90% plus.

I just want to mention for people who have sort of associated with NetScout we certainly both Network General and NetScout business is really a continued sale. You start with using one part of the network and then you're using the other part. So while most of the companies have two kinds of businesses - new customers and existing customers renewals, we have the third part which is supplying the same product in other parts of the network and that brings the number to this 90% plus level. That is what is going to continue. It's a follow-up sale in a different part of the network which technically is new business but in our business model it's typically an old customer.

The number is now at my fingertips; it's about 90%.

Anil, if you were to look at your international business outside of the wireless vertical any other vertical that sort of stood out last quarter?

I don't have that. Maybe David has something. But financial is also very strong there and those were -- it's not new information. That was the case before,especially for Network General also. I believe both financial and telco was strong.

Financials was 32% of orders, telco was 16 (multiple speakers)

He's asking do we know which other business was stronger internationally or was it mostly telco?

I'm sorry, it was principally telco and financial services internationally.

David, just back on the GAAP gross margin guidance, can you review how we should be thinking about that as you see this product mix shift between historical NetGen and NetScout just through the first couple of quarters how we should be thinking of that?

In Q1 we're going to continue to have shipped some legacy products of both companies at their legacy gross margins. So the mix will -- we had pretty heavy mix in Q4 of NetGen products. And that caused a bulk of the four point drop quarter to quarter. We expect to see a shift back which would cause an increase in the June quarter.

And then beyond the June quarter over time we will be coming out with increasingly integrated products and those integrated products will be targeted to have NetScout like margins. So the issue of mix swing between legacy products will disappear. And whether that happens completely in the June quarter or that disappearance by the end of the June quarter leads into September quarter we're not clear yet.

Mark Gomes - Pipeline Data.

How are you doing guys - great quarter. This is the second straight quarter of strong outperformance versus expectations. As we follow the progress of the NetGen acquisition your guidance has incorporated your concerns along the way but your results have shown that those concerns have not come to pass. So in providing your '09 guidance, if your sales and integration concerns don't come to pass as the other concerns haven't, is it safe to say that you'll continue to show the kind of upside we have seen over the past two quarters?

That's what we hope to do and obviously what like I said we won't shy away from raising the guidance if we feel so. I think we're entering from the strongest quarter to the weakest quarter, traditionally and that's why I think we have to just wait and see how things work out and whether there's any external effects in the financial area which will apply to us and so that is one of the reasons. We want to provide something which we can count on moving forward.

Let me for the record reiterate, our guidance is our guidance.

Okay, can you just talk a little bit more about your opportunity with carriers as they move to IP networks how that affects your business? And then also can you talk a little bit about whether virtualization helps or hurts your business going forward?

I think first of all the main reason if you were to look at NetScout's business or Network General business two years ago they were less than 5% or so of business in telco or maybe less than 10% but wireless service providers business was even less than -- a smaller portion of that and there have been two technologies -- GSM outside of the US but mostly outside of the US and CDMA inside of the US.

And Network General and NetScout has been focusing on actually on different areas. And as we integrate both the products and provide the common set of features for all wireless service providers I think we can go back and really do some very interesting things which is why we're successful in the enterprise space. Having said that there are some entrenched incumbents and competitors in the service provider space or telco space who are also trying to move from analog to digital, moving from analog voice monitoring and the customer experience system to IP.

So we think the opportunity is great. We have already moved on to a higher percentage of number and we're making actually a lot of investments both on the sale and engineering side to fully leverage that opportunity. So we think it's a great opportunity. We have the best product in the market but we want to be well known there. What was the second part of the question?

As virtualization continues to proliferate how does that impact or business?

Basically virtualization -- we really don't do anything for server virtualization -- server virtualization needs to be supported by network virtualization and many people are not talking about that. And we think that is going to be a biggest thing from a network point of view. To support the sever virtualization or storage virtualization you need to monitor the network at the virtual level and that is the new value proposition of this K2 product and we believe that technology we have which is based on packet flow combined together for Network General and NetScout investment in that area is the only or perhaps the best technology for that area.

So in that sense virtualization is a positive thing. But if virtualization from a server point of view is really not that important but it does increase the amount of traffic on the network and creates more performance problems from a network perspective. So it is an opportunity in that sense.

Congratulations again guys. Looking forward to more forward progress.

(OPERATOR INSTRUCTIONS) J.D. Padgett, Boston Company Asset Mgmt, LLC.

Two quick ones. One was just interest expense, a little surprised how high that was given the capitalization profile. Was there anything that was sort of one time in expense in that or is that about what we should expect it to run going forward?

If you're talking about pure interest expense there's nothing more than basically the debt, the $100 million debt interest carry.

Yes, I was looking at all that kind of netted together the $1.9 million expense.

Well let me dive into that for one second. You had another quick question?

The other one was just to make sure I understood the comment about the tax rate. Would it be right to think if we took the $0.55 which is kind of the midpoint of the non-GAAP EPS range times whatever share count you want to use, 40.5 for the sake of argument, you get around $22 million net income from that and then divide by 0.66 to get pretax? So that is the 34% tax rate we should be using there? Is that the right way to be looking at that?

On a non-GAAP basis, yes.

Okay so that 34% kind of blends together, the GAAP plus the non-GAAP addbacks, is that right?

Yes. Back to your interest expense question, in interest expense this quarter and it may continue for -- it should not continue -- sorry -- going forward. We had some foreign exchange translation expense to the tune of about $700,000 from balances that were involved in the Network General international tax structure that I had mentioned briefly earlier. We have -- we're in the process of changing that international -- collapsing that international tax structure to reduce our foreign exchange exposure and we do not expect that to continue going forward.

So that pure net interest expense going forward should be closer to 1.2 or 1.3? Or maybe even declining as you're paying down some of those balances?

I think we better have another conversation with you about this because those numbers don't sound right and I'm not sure where you are -- our quarterly debt payment -- net interest payment is about $2 million

But then you have some interest income from the cash, right? As an offset?

Yes, that's true. It may be about that size.

Thank you.

Mark Kelleher, Canaccord Adams.

Thanks just wanted to ask one more question guys. Do you have a goal for your operating margin as you go into next year?

Yes, we have had the operating margin goal which would carry forward after the acquisition of high teens operating margin and I think if you -- as you look at the potential progression over the year, we would expect on a non-GAAP basis that we can start to approach that range by the end of the year.

At this time there are no further questions. I will now turn the call back over to the presenter.

Thank you very much, thank you Vanessa. Thank you all for joining our call and for a very strong insightful round of questions. We look forward to talking to you again at the end of our next quarter in about 90 days. Thank you and good evening.

This concludes today's NetScout's fourth quarter fiscal year-end conference call. Thank you for your participation. You may now disconnect.