Netscout Systems Inc (NTCT) 2011 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to NetScout's third quarter fiscal year 2011 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 will be given to you at that time. As a reminder, this conference call is being recorded. With us today, is NetScout's President and CEO, Mr. Anil Singhal. He is accompanied by NetScout's Chief Financial Officer, Mr. David Sommers, and NetScout's Chief Operating Officer, Mr. Michael Szabados. 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 2011 conference call for the period ended December 31. Before we begin, let me remind you that during the course of this conference call, we will be providing you with a discussion of the factors that we currently anticipate 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 2011, and our new product releases. It should be clearly understood that the projections on which we base out guidance and other forward-looking statements and our perception of the factors influencing those projections are highly likely to change over time. Although those projections and the factors influencing them will likely change, we will not necessarily inform you when they do.

Our Company policy is to provide guidance only at certain points in the year, such as during the quarterly earnings call. We do not plan to update that guidance otherwise. 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 discussion of the risks and uncertainties that could cause our actual results to differ, see the specific risks and uncertainties discussed in NetScout's annual report and on Form 10 K for the year ended March 31, 2010 on file with the Securities and Exchange Commission.

Also in our discussion tonight, non-GAAP revenue excludes the impact of early-adoption of new accounting principles and the [purchase] accounting adjustments representing the reduction to fair value deferred revenue. Non-GAAP net income excludes the non-GAAP revenue adjustments as well as share-based compensation expenses, amortization of acquired tangible assets, certain business development costs, and related income tax adjustments. I will now turn the call over to Anil Singhal, our Chief Executive Officer.

Thank you, Cathy. We are pleased to be reporting another good quarter. Year to date, new business bookings in the third quarter were 70% over the same period. Our new business is a major benchmark of our success in the market. I am also happy to report that based on results for the first three quarters of fiscal year 2011, we are on track to meet the yearly guidance we provided in April 2010. We believe this is an indicator of a strengthening economy as well as our continued market leadership, and we expect this growth trend will continue. Michael will discuss a new [IDC] market analysis that supports our view in a moment.

Year to date, total bookings, including new business and service [renewals] are up 6% over the first three quarters of last year. [Renewal] bookings down 16% year to date because of last year's [bubble] of [early and renewals] that began in Q3. If those renewals had [acted normally] renewal bookings would have grown 7% year to date, yielding an adjustable total bookings growth of 14%. We expect growing demand for our market-leading solutions as current and new customers begin to use their IT [and network] infrastructure increasingly in support of critical elements of their [optimization] value propositions. In addition, we expect new business bookings from the [telcom] sector to continue to accelerate in calendar 2011, propelled by [organic] investment in their 4G and LD networks.

As we have already shared with you, we have been investing heavily in developing our R&D sales and services infrastructure to prepare for growth. And as a result, operating expenses grew faster than revenue in the first [half] of the year. During this quarter, operating expense growth [de-escalated] to 4% year over year, driving market expansion. Operating margin came in strong at 36%, up two points from a year ago and three points sequentially, and near the top of our operating margin range. EPS growth was strong, up $0.06 year over year, and up $0.08 sequentially. This is also in line with our full-year guidance. As we enter our fourth quarter, we are reaffirming our fiscal 2011 guidance but narrowing the range with one quarter remaining. That guidance is within range of the guidance originally issued in April 2010.

Turning to other news during the quarter, we officially announced our next generation deep packet analysis technology, called Adaptive Session Intelligence, or ASI. This new patent-pending technology, which will be rolled out in [successive] releases over the next year across our nGenius Service Assurance product growth, will greatly enhance our business value to our customers by providing them more effective solutions while managing comprehensive service delivery management. We believe this will be an industry-transforming technology that will give [ID augmentation] a more unified (inaudible) service delivery transaction and provide a better understanding of the interrelationships between performance of the infrastructure and application.

This will be particularly relevant to [next generation] data-intensive 40- and 100-gig deployment and the growing complexity of [multi-D application] architectures with increasing levels of virtualization and physical and virtual [multi-domain] traffic flows in the cloud environment. We look forward to [our] last quarter and reaching our fiscal year objectives of improved growth (inaudible) and increased shareholder value. We are working diligently to deliver new and improved product solutions for the enterprise environments of the [this] market. Michael will now talk about some of our specific accomplishment in this quarter.

Thank you, Anil. Today, I want to review with you some of the operational [advancements] we've made during the quarter. As we discussed before, we have been making significant and ongoing [operational] investments in the solutions for the wireless service provider market. As a result, we now support 2G, 3G and 4G deployment. This past quarter, [we began engineering] a service solution for wireless carriers, with complete CDMA 2000 support, extending NetScout's proactive IP management capabilities to large US and international carriers using this technology. This [release delivered subscriber] visibility with session analysis, as well as a broad range of KPIs, or Key Performance Indicators, and we will extend our ability to support [all] IP mobile deployments.

We have also extended our LTE or Long-Term Evolution support by working proactively with our top operators on multiple continents, and have deployed our products in a number of pilot installations. Through participation in these pilots, we are gaining clear-cut direction from our customers who are early-adopters of LD and elevating those requirements for [prioritization] of [LD] the investments to meet their service and [solution] needs. This release further exemplifies NetScout's strategic direction to build on our leadership IP monitoring foundation a highly scalable solution for subscriber visibility, user experience, and business intelligence.

These solutions are critical to and highly valued by service providers to proactively manage their subscribers' experience and exploit the business opportunity presented by the exploding mobile market. A recent announcement of 10 new service provider customers worldwide is tangible evidence of the value for investments in this market. These new deployments are in the United States, China, Indonesia, Egypt, and the Middle East. NetScout's IP services [and] solutions are now deployed in 130 service provider networks across 42 countries.

We are committed to continue to build our technology leadership and to transform all IP services are managed and assured for our Telco customers providing mobile services to consumers and businesses worldwide. In previous quarters, we have talked with you about our work with Cisco and HP to develop [engine use interactive agents] providing a software-based solution deploying [engine use] technology in their network infrastructure offerings. I am pleased to report that we are seeing significant interest and acceptance of these offerings, allowing us to extend the reach of our customer service assurance solutions to the edge of the network, allowing them to better manage their [remote office] operations. We are in a number of field trials, and anticipating a ramp-up in purchases of these offerings.

NetScout's technology leadership has been recognized by the industry through a couple of awards given out in the past quarter. Our service assurance solution received the 2010 4G and LTE Visionary Award sponsored by the Technology Marketing Corporation. This award is an affirmation of NetScout's vision for enabling wireless broadband services and work to advance the future of mobile broadband in 4G and LTE deployment. Another area, our Adaptive Session Intelligence technology, Anil mentioned earlier, has received Frost and Sullivan's Global 2010 Enabling Technology of the Year for Network Performance and Application Monitoring Award. In granting this award, the Independent Research Company stated that, I quote, the ASI technology will increase the competitive position of NetScout in the application monitoring and end user [experienced] management market, unquote.

Separately, IDC recently announced the market share statistics for network management market for calendar 2009. As in 2008, NetScout continued to be the market share leader with 11% of the total enterprise market, ahead of IBM and [CEA] Technologies. In this announcement, IDC also forecasted market growth in 2010 of roughly 9%, to $2.5 billion and 7% compound annual growth rate over the next five years, to $3.4 billion by 2015. IDC believes the enterprise network management market is returning to a steady growth path as the importance of the network and the need to quickly resolve performance problems and keep the network operating at peak performance levels continues to grow.

Finally, I am pleased to report that we hosted another record-breaking user forum series, that we call Engage, in San Francisco and Paris. We had more than 300 attendees from over 150 of our largest customers and [retailers] worldwide. Engage has been, for a decade, our biggest annual event showcasing our product direction and developing our customers' skills in the broader application of our solution. At Engage 2010, we were able to launch to our customers the new Adaptive Session Intelligence technology Anil just mentioned earlier to great reception by the audience. Thank you, and I would like now to turn the call over to David.

Thanks, Michael. Our quarterly financial results are included with our earnings press release. We report our results on a GAAP basis as well as a non-GAAP basis. Our non-GAAP results eliminate the GAAP purchase accounting effects of our acquisitions by adding back revenue related to deferred revenue revaluation and removing the amortization of our acquired intangible assets. In addition, we removed the GAAP effects and the related impact of these adjustments on the provision for income taxes of stock-based compensation and of our early adoption of new accounting principles. Our non-GAAP results now also exclude certain extraordinary business development expenses for outside services that we incur from time to time in pursuit of potential acquisitions.

The differences between GAAP and non-GAAP are disclosed in reconciliation tables in the press release financial tables. 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. Starting this fiscal year, we have adopted, along with many other technologies, a new revenue accounting policy that we expect may begin to materially affect our revenue recognition in fiscal 2012.

As we discussed last quarter, for most of our product sales, this will result in minimal change to revenue. Our hardware products, like the inFinistream, will fall under the new guidelines. But, we anticipate that revenue impact will be slight. For a portion of our software and [applianced] software sales, we now expect that in fiscal 2012 we may begin ratable revenue recognition over the term of the maintenance period sold with the software. This will result in slower recognition of software revenue than we would recognize under the current rules, and therefore, lower period revenue, particularly during the initial phase-in period. We are reporting to you revenue and earnings based on both methods of accounting during the phase-in period until ratable recognition is fully established in our results.

We will report current and historical GAAP and non-GAAP results in our press release. And in this conference call, I will be discussing current GAAP and historical non-GAAP. The historical GAAP and current non-GAAP were presented as part of a financial summary table in the press release. Accordingly, the results discussed now are presented as GAAP under the new and current accounting standards [of] non-GAAP [under] the [form] of historical accounting standards. At a future date, we'll discontinue reporting of historical GAAP as the reporting rules allow, and discontinue historical non-GAAP when non-GAAP reporting under the new accounting standards becomes more meaningful in the understanding of our operational results. And we'll also discontinue all of this preamble.

Now to our financial results. For the third quarter, GAAP revenue was $76.3 million, up 8% year over year. Non-GAAP revenue was $76.2 million, up 7% year over year. Product revenue on a GAAP basis was $43 million, and on a non-GAAP basis, $42.9 million. Both GAAP and non-GAAP product revenue was up 5% year over year. Service revenue on a GAAP and non-GAAP basis was $33.3 million, up 11% year over year. Our GAAP gross profit for the quarter was $60.2 million. GAAP gross margin was 79%, up 1 point year over year. On a non-GAAP basis, gross profit was $61.2 million, and gross margin was 80%, no change year-over-year.

GAAP income from operations was $16.2 million. GAAP operating margin was 21%, up one point from a year ago. GAAP net income for the quarter was $11.1 million, yielding earnings per diluted share of $0.26. GAAP net after-tax margin was 15%, up three points from a year ago. GAAP income from operations was $19.7 million, and operating margin was 26%, up two points from a year ago and a point below the high end of our target operating margin range. Operating margins have begun to expand as we had expected, with much of the sales and development and hiring that we embarked upon 18 months ago behind us. While we still have some additional resource investment to make, we will be focused principally going forward on driving productivity and growth from that investment.

Non-GAAP net income was $13.2 million, or $0.31 per diluted share. Non-GAAP net after-tax margin was 17%, up two points from a year ago. The non-GAAP adjustments to our GAAP results are summarized in the reconciliation table included with our press release. The provision for income taxes is recorded based on a full-year effective tax rate of 34% on a GAAP basis. Our GAAP tax rate in the quarter is 30%. Our full-year tax rate is reduced to 34%, as I mentioned, from 36% in prior quarters because of the December tax legislation that provided an R&D tax credit retroactive January 1, 2010, and for a reassessment of our domestic manufacturing tax reduction.

We accept our fiscal 2012 tax break to be 35% on a GAAP basis. We have used the statutory tax rate of 38% to tax-effect our non-GAAP adjustments. The effect of the tax rate change on EPS in Q3 was $0.02. And, we expect it will be an additional $0.01 in Q4. Our current long-term model, which is subject to regular review, remains as follows. Non-GAAP gross margin is 78% to 81%. R&D expense to revenue is 13% to 15%. Sales and marketing expense to revenue, 33% to 35%. G&A expense to revenue, 6% to 8%, yielding an overall operating margin range of 24% to 27%. Cash and short-term and long-term marketable securities hit a new high of $210 million, up $14 million in the quarter and an increase of $59 million year over year. Free cash flow was $12.6 million. CapEx was $1.6 million, depreciation, $2.0 million, amortization of acquired intangible assets, $1.5 million. Long-term marketable securities include investments and auction rate securities valued at $21 million even.

During the quarter, $300,000 of auction rates were redeemed at par. As of December 31, the value of these securities includes a temporary decline in value of $2.7 million below par to reflect with liquidity concerns. All of these investments have investment-grade ratings ranging from AAA to A, with underlying support by federal government through the federal family education loan program. We believe they have no credit issues, only short-term ill-liquidity. We've classified these securities as long term on our balance sheet, and recorded the temporary decline in value to accumulated other comprehensive loss on the balance sheet. With our strong cash position and positive cash flow, the ill-liquidity of these securities poses no overall liquidity problems for us.

Accounts receivable net of allowances was $56.8 million, up from $41.4 million last quarter, and down from $57.7 million a year ago. Day sales outstanding were 68 days for the quarter, above our typical range of 45 to 55 days. This is up from the prior quarter of 53 days, but below the 74 days of last year. Inventories were $8.9 million, down from $11.4 million in the prior quarter and up slightly from $8.7 million a year ago. Inventory turns were 2.6 times. Turning to other metrics, revenue contribution from direct customers was 36%, and reseller revenue 64%. Revenue from international sales was 31% of total, up one point from last year. Europe delivered 17%, up one point from a year ago. Asia came in at 6%, up two points from a year ago. Other International Sales were 8%, down two points.

Summarizing our large deals, 166 customers gave us orders over $100,000, an increase of 33 customers over the same period last year. 35 customers give us orders over $500,000, up eight from last year. We received 15 orders of $1 million or more, of which five came from Telecom, our wireless service provider business, four came from Financial Services, two from Government, two from Healthcare and one from Manufacturing. This compares to a year ago, $13 million or more orders, including five from Telecom, five from financials, two from Government, and one from healthcare.

We saw total bookings from the following sectors in the quarter. The Enterprise sector was 63% of total, Telecom, 23%, and Government 14%. Within the Enterprise, the financial services sub-sector was 26%, healthcare was 11%, followed by energy at 7% and high- tech at 5%. A year ago, the Enterprise sector was 58% total, Telecom was 28%, and Government was 14%. The financial sub-sector of Enterprise a year ago was 28%.We also had strong contributions last year from other Enterprise sub-sectors, with healthcare at 7%, energy at 5% and high-tech at 4%. Going forward, we will follow the normal industry practice of including the financial services sub-sector in our Enterprise results.

Total bookings in Q3 were $80 million, down $7 million or 8% year over year. New business bookings were $54 million, down $2 million or 4% from a year ago. New business bookings are strongly influenced by the lumpiness of our telecommunications service provider business. This quarter, our major wireless telco customers were focused on their LTE rollouts. And as a result, we did not see the normal calendar year-end surge of orders from them. We continue to expect that the success of our LTE product development will result in significant accelerating order flow in Q4 and fiscal 2012. Our service provider pipeline is substantially stronger now than it was a year ago, when we experienced a major surge in Tier 1 carrier orders.

The current pipeline reflects our LTE prospects, which are also demonstrated by a growing list of LTE design wins, including Tier 1 carriers in the US, Europe, Japan, and Korea. The bookings growth from these and other successes is not yet substantially reflected in our results. In the Enterprise, our new business bookings grew 20% over Q3 last year. The financial services sub-set of Enterprise grew 7%. Correspondingly, the growth of the rest of the Enterprise sector was 29% year over year. The Government sector globally was down 4% year over year. Service contract renewal bookings were $25.8 million, down $4.9 million or 16% year over year. The service renewal bookings decline was entirely due to the abnormal amount of multi-year and early-year renewals from a year ago.

Normalizing for those bookings, renewal bookings would have grown had the renewals booked in the proper period, the period of the contract start, would have grown 14% rather than being down 16%.We believe, because of the volatility of our quarterly bookings comparisons, that it's important to view these Q3 bookings in the context of our year-to-date performance. On a year-to-date basis, total bookings are up 6%, or as adjusted for the fiscal 2010 renewals bubble, up 14%. Total bookings up 14% as adjusted. New business bookings are up 17%. This growth is approaching our long-range target growth of high teens revenue annually. Renewals as adjusted would be up 7% year to date, naturally lagging our new bookings growth. Product backlog at the end of Q3 remained immaterial. Deferred revenue was $94 million, up $9 million or 10% year over year.

And now for our guidance. We are reaffirming the tightening the range of the full-year guidance that we issued originally in April. We expect current and historical GAAP and current and historical non-GAAP revenue to be in the range of $290 million to $294 million. This guidance implies that fourth quarter current and historical GAAP and current and historical non-GAAP revenue will be in the range of $78 million to $82 million. Current and historical GAAP net income per diluted share is expected to be in the range of $0.83 to $0.87, and current and historical non-GAAP net income per diluted share between $1.01 and $1.05. Accordingly, implied fourth quarter current and historical GAAP net income per diluted share is expected to be between $0.21 and $0.25. Current and historical non-GAAP net income per diluted share is expected to be between $0.26 and $0.30.

We expect, as always occurs in Q4, to experience a seasonal upward pressure on expenses from payroll taxes and health benefits. The fiscal 2011 non-GAAP revenue expectation before and after the accounting change that we have discussed excludes the purchase accounting adjustment to fair value of approximately $130,000 of deferred revenue. And the non-GAAP net income per diluted share expectation before and after accounting change excludes a deferred revenue purchase accounting adjustment that I mentioned, as well as share-based compensation expenses of approximately $5.7 million, amortization of acquired intangibles of approximately $5.9 million, certain business development expenses of approximately $900,000. And the related impact of these adjustments on the provision for income taxes of $4.8 million.

We are not today providing guidance for fiscal 2012. We will provide that guidance with our fourth quarter results in 90 days. However, we expect that in fiscal 2012 we will further accelerate revenue growth over 2011, and that we will continue to expand operating margins. That concludes our financial discussion this afternoon. Thank you for joining us for these prepared remarks. And we look forward to taking your questions. Sarah, would you go ahead, please?

(Operator Instructions) Your first question comes from the line of Alex Kurtz from Merriman [Capital.]

Thanks for taking the question. Dave, let's start off with your last comment about looking out into fiscal 2012. Is that increased confidence coming from the improved new customer bookings that you are seeing in the Enterprise space? It seems like you have focused on that vertical on the call. Any additional color about what you're seeing in that general Enterprise base would be helpful.

We are seeing strength in the Enterprise vertical, including financials. Financials strength has been around for a while. Other areas of Enterprise are starting to pick up. So, our optimism that we're going to be on our path toward our long-term targets is driven in part by that. But also in large part by the success that we believe we're having with our service provider customers. Those two verticals, of course, make up the vast majority of our business. As they both start to grow together, that should bode well for us going forward.

I think one thing to add, Alex, will be [we have made] a lot of investment, as you mentioned in our [R&D] sales last year or this Telco sector. We are not really [seeing] the benefit of this. And so, a lot of good business in the LD and 4G areas ahead of us. Just to add to the confidence level of what David talked about.

Okay. And just to clarify, did you see a change in improvement specifically in the December quarter around your execution in the Enterprise space?

Yes. Let me state it differently. We saw a change in the uptake, the reception of our execution. We've had these discussions for going on a year now about -- in one form or another -- about the growth in the Enterprise and our expectation that the recovering economy would bring back the initiation of major projects from Enterprise customers. We saw it first in financials, and now we are starting to see it elsewhere. So, this is not unexpected for us. And our execution has been to nurture and encourage and bring to fruition those projects. That takes a while, as we've said. We always lag on the way up, as we've been telling you. And we're starting to see that effect now. So, it's not as if we weren't executing well before and now we're executing better. It's that our execution just takes a while because of the project nature of our business.

Quick question them. On the LTE or just on the wireless front, were you surprised you weren't able to close as much business as you were expecting? Or is that sort of -- you won the business but the actual deal flow was always pegged for the March quarter?

So, a little bit of both. We expected that there would be some normal budget flush from the carriers. We saw some last year and the year before. What we found is, as I mentioned, was that they were so focused, each one in their own way, but the major tier 1 guys so focused on getting their 4G LTE initiatives going that there was either less capital available or less mind share available to do what they had been doing, which is what we had been helping them to do, which is to build out and manage their existing 3G networks.

That part was a little bit of a surprise. It was not a surprise to us that we didn't get more major LTE business, because the investment in that business from the real big tier 1 guys is still in the future, right? We are competing hard for that. The business is competitive, and the investment that we've made over the last 18 months, that Anil mentioned, is to enable us to win a lion share of that business. And we still expect that.

Thanks

Thank you.

Your next question comes from the line of Matt Robison from Wunderlich Securities.

Good afternoon. David, the backdrop for revenue acceleration in 2012 then just comes down to Enterprise waking up and the IT [and the ran] basically LTE and HSPA-plus uptake and accelerating next year. Are those the two main factors we should be anticipating?

Those are the two largest ones. Underneath the covers of that, there's a lot.

Okay.

A lot of market expansion in the service provider space and in our sales footprint. You saw an up tick in our Asian share performance. We are involved in a lot of seminal work with a lot of carriers in Asia, in more than a handful of countries. That's not really in our results yet, that we expect to be. So, it's more than just the tier 1 guys in the US starting up their new investment cycle. In the Enterprise, we have been making significant investments in the financial area and in our integrated Asia. That's not new news. That's old news. Those investments we expect to start to bear fruit. Part of that is our expanded capability to address new projects and new uses of networking technology that our large customers, many of them long-standing customers, have started to initiate. We've seen that activity. We've talked about that in quarters in the past -- recent past about the visibility of the un tick in activity, and we're starting to see some of it come to --

I think one thing more to add is that throughout our product line we'll be embedding the new [high-tech] technology, which is what David was talking about. There will be some new users in the area of end-user experience and business intelligence. So, we see there are more and better users, or bigger users, of our data, which we are collecting today. We'll be able to deliver that better than anybody else through the ASI technology.

That was my next question. When will ASI start to affect bookings?

I think it will be throughout the next year. It's going to be embedded in the complete product line complete product line over the 12-month period. We'll have something in this quarter, but that product line probably will be toward the end of the year. I think the second half we probably will see -- the second half of this coming fiscal year is [when we'll see a bigger impact.]

Let me just put another fine point on that. ASI, as most of our technology innovations are rolled out, is not a product that's going to be delivered at a particular point in time that's going to start a big product buying cycle. It is a technology that's going to be infused, as Anil said, throughout our product line. And as Michael talked about with our Engage announcement to our customers about it now. And the fact that that technology is innovative, as the awards around it indicate, and our customer enthusiasm makes them more willing to buy our products now. As part of that, as Anil pointed out, that enthusiasm that is causing them to buy current products. Because when ASI comes out, they will get it, under our maintenance agreements.

So, we should look at it as a version or field upgrade type of thing, then.

That's correct. The enthusiasm for it is in the marketplace now and growing. They haven't seen it yet, so it's a promise today. But it will come.

Thank you. That's it for me.

Thanks, Matt.

Your next question comes from the line of Mark Kelleher from Dougherty and Company.

Thanks for taking the question. On the balance sheet, David, could you just give us some more insight on why the DSOs were up, and maybe talk about the sequential jump in deferred revenue? What was driving that?

Sure. DSOs often jump for us at this time of year, and they're related -- the two factors in one dimension are related. At this time of year, as you know, particularly last year when we saw it big time with early- and multi-year renewals, this is our renewal season. It's typically tied to our customers' budget cycles, which happens in December and some of it rolls over into the March quarter. So we get these big renewals, and they often come in toward the end of the quarter. There is little or no revenue that comes from them. So, part of the DSO equation is unaffected, but there is often significant receivables from them. So the other part is. And we don't try to adjust for that. So, DSOs this time of year typically jump up -- it jumped up less this year than last, because we didn't see the same kind of bubble of renewals, of abnormal renewals this year. That's a major driver. And that's also the driver seasonally normal of the growth in deferred revenue. So, in the December and March quarters, we book a lot of deferred revenue. And then in the June and September quarters, we typically take it down off the balance sheet and amortize it in.

That's very helpful. That's enough. And then on the income statement -- On the government side, can you tell us if you are seeing any change in demand out there? A lot of speculation on government pulling backon spending. Is there anything you can detect over there?

We don't see a big difference, one way or another. We are not hearing anything. about cutbacks or anything. But we are under-penetrated in the [that area] so, hopefully we can extend our reach there. Overall, our customer base is about the same as last year.

So, no trends that are visible from the government buying patterns. It's more just an anomaly for us.

Okay. Thanks.

Yes, sir.

Your next question comes from the line of Eric Martinuzzi from Craig-Hallum.

Thanks. Based on your guidance for Q4, we're looking at about 11% revenue growth for the Company at the mid-point, and maybe a 24.5% or so on the adjusted operating margin. So, on that 11% revenue growth, we've got about a 300 [bips] expansion in the margin. Given your commentary about growing -- expecting to accelerate the revenue growth in 2012 as well as get the operating margin expansion, what are the puts and takes as to why that might be different? If we layer it on, even just the same growth rate, why would we not get that same operating margin expansion?

I'm sorry, Eric. Can you boil that question down into something simpler? I apologize. I wasn't able to -- is the question why, with accelerating revenue, are we going to expand operating margins?

No. I do expect you to expand the operating margins. I just don't want to run with scissors here. Are there investments that we would be looking at, operating expenses for cost of failure [customers] -- r?

Is there a reason why it wouldn't expand. I understand your point now. Sorry. We still have, as I mentioned, some investments to make that aren't behind us. There is a reason why you can't take a fixed expense base and just say revenue growth is on top of a fixed expense base. In addition, you may recall that our incentive plans have some swing in them. And you may also recall that a year ago, our performance was -- as a Company, was down. So, the incentive plans weren't as rich. This year, our performance as a Company is up, so our incentive plans will be richer this year and next year potentially. So, you will see that expense growth.

You should also expect to see, as markets heat up, some additional expense to protect our investment in our employee base, both in terms of healthcare costs and in terms of compensation. So, there are reasons why, but perhaps the major reason why is over this year of fiscal 2011, we have phased in the existing hiring. So that when we start fiscal 2012, that will all be in the then instant run rate, the opening run rate. But at a much higher level than the average in fiscal 2011. So, you will see a natural rise in expense levels just because part of the expense, the run rate, was in fiscal 2011, but it's all in fiscal 2012.

What is the projected headcount for 3-31-2011 versus 3-31-2010?

Bear with me a second. I can give you some of that, I think. Headcount at the end of last year was about 790 , and headcount at the end of this quarter last was about 830. And we're going to add maybe another 40 people, many of whom are already in the works. Okay? Much of that, as I said -- some of it's ahead of us. Much of it's already -- offers out and people, if not accepted as we sit here on January 20, pretty

Okay. But about a 10% boost in the headcount year on year. Lastly, maybe I don't understand where NetScout is deployed, but on your carrier commentary I would have thought that NetScout -- we've got carriers out there with LTE customers today. I would have thought that would have benefited NetScout last quarter. You are talking about, we're in some pilots and we should benefit in the future. Help me understand how the product is used by the carriers.

I can mention a few things and then maybe Michael and David can add. We are in a lot of pilots, but they have not really started actively buying beyond the labs right now. We are in several big pilots right now. There are a few places in Japan and although there [will be a product for LD] -- But in the rest of the places, most of the pilots are still in progress. For this year, most of the buying has been on 3G. It would have been better if a lot of the investment would be going to 4G. So, the 4G projects have been [escalated], but still not really materializing in revenue right now.

So, their current infrastructures are substantial enough to handle the traffic they've got right now. There hasn't been a crush or --

One illustration of that to keep in mind, one of the large, most advanced earliest LTE players, of course, is one of the big players in the US. As they've rolled out their 4G LTE rollout, what they've done first is data cards, air cards. No voice and no applications that are with a managed application. So, unlike the 3G network, where they're selling applications that you expect to perform, really most of what you can do in their 4G network is Internet connection today. And they [have] high-speed and all of that.

So a lot of the 4G LTE stuff that's going on today is very, very early. The press exceeds the execution today. Therefore, the press exceeds the buying to manage today because they don't have to just yet. But they will. So, there is a lag time here between when they start to talk about it and even actually do it in the way they're implementing it, and when they will really start to need the kind of intensive monitoring that they will get from us and others.

Fair enough. Thank you.

You're welcome.

Your next question comes from the line of Aaron Schwartz from MKM Partners.

Good afternoon. David, I think you've always talked about the service provider segment sort of being lumpy given the larger deal flow there. It seems like maybe that's what occurred here. But as we move forward into the first half of calendar 2011, is there anything specific that gives you the confidence that the activity in the 3G space will pick up here to bridge you until the 4G deployments pick up a little bit?

What we expect is some of the 4G deployment happening in the first six months of this year. So, that's some of the pilots which we are ready going on. We expect some business coming through that, maybe in the first half. The people who select us, companies who select us for 4G will also use it for 3G expansion. So, the biggest [conflict] we have is that our product line is mostly complete now . We can [start] with any of the [products,] whether it's GSM or CBNA or [LTE] we'll be in a position to do that as the investment kicks in in this area. So, that's where the confidence is coming on. We are far ahead of where we were this time last

Okay. That's helpful. And then I guess a similar question on the Enterprise side. It was certainly nice to see that pick up a little bit. You probably had some year-end budget flush phenomenon there. But it sounds that you do expect that improving momentum in the core Enterprise to continue here in calendar 2011. I just want to make sure I understand you correctly in terms of your outlook for that sector.

That's right. You did.

Okay. The last question I had was on the balance sheet in terms of the deferred. If you shift back to shorter term from longer term, is that just a phenomenon of sort of normalizing for the trends you saw in the second half of last year where you had some [pull forward] of multi-year contracts?

You're talking about the contract [link]. Yes, it's returned to normality. We normally don't have very much content of multi- years. It's always been a little bit, but not much. For reasons that we talked about a year ago and nine months ago, that sort of expanded on us greatly in Q3 and Q4. We made some changes to our sales comp plan, and the environment's changed. As that is our big Enterprise customers that a year ago were saying, maybe not new product orders, but I'll give you multiple years of maintenance renewals. Now, we're starting to say, okay, I can give you new product orders. So, the sales force can do what we really want them to do, which is not just sell multiple years of maintenance, which is great, but to sell significant new product to deployments.

Okay. And I guess maybe one related question with maybe the multi- year deal that happened last year. If these customers that are locked into those multi-year deals, maybe want access to ASI, do they have to do anything contractually to get access to that? Or, is that just fully within their rights?

We deliver these new technologies as part of upgrades to the software that's deployed on our products. If those products are on maintenance, then they get the new technology.

But one thing to add is whenever this happens, we are also seeing the expansion in the same customer base. Once they get excited about getting this stuff for maintenance, they tend to deploy our products in most places, or [additional] places. So the net effect of new technology, even though they are getting at no charge for the existing maintenance products, it typically involves buying more products in other areas.

It's an expansion of the value proposition that we deliver. And so, greater value proposition causes them to buy more and do more with it.

Okay. Terrific. Thanks for taking my questions.

Thank you.

Your next question comes from the line of Kevin Liu, from B. Riley and Company.

Good afternoon. In the reconciliation that you showed of $600,000 related to [business] development, it looks like from your prepared remarks, that's outside acquisitions you're looking at. Given that you're expecting $900,000 for the full year, I'm just curious if we should take that to mean that the discussions here are ongoing and whether we should expect something in the near term.

I can't comment on that. Obviously, we have started to carve that out because although acquisition discussions will come and go, we don't want them to distort our results abnormally. So, you will see a rise and fall in that expense. Although, there is no certainty that any particular acquisition that we are spending money to pursue will close. But you should expect us to see us actively in the acquiring mode.

And in terms of what types of acquisitions you might be looking for right now, it sounds like you have filled out much of the capabilities you needed for targeting the service provider market. What sorts of things would you be looking for right now?

I think there are a lot of things that would be complementary to what we are doing. We talked about that NetScout has been very big in the data space, and we could look at things [video] space to complement what we have been putting in. So, there are a lot of things which we can turn to the existing customer base. So, we'll be looking at things which can allow expansion to the existing customer base, expansion within the existing customer base.

And just to dig into the service provider market a little bit more, I wanted to clarify whether -- you mentioned several design wins over the course of the year. It sounds like you're expecting that to contribute meaningfully to bookings, especially over the course of fiscal 2012. Should we take that to mean that these are no longer as intensely competitive anymore? That you feel like to some extent these bookings are in hand, and you just don't have a great sense for the timing? Or are these still fairly competitive, where you've made the investments and you still need to make sure you get the customer win?

It's a mix. There's some very large tier 1 carriers where you will win. We have one, and [we'll] be designed in for some purposes. And other vendors are also designed in. Every time there's a new proposal, a new major project or expansion, then the competitive decision can be revisited. There are others that typically are smaller, where once you're designed in, that's pretty much it for a long time. So there is a mix.

There will be lot more deals than what we had last year, bigger deals. Just because of that, that simple reason, we'll have more competition also.

Thanks for taking my questions.

You bet.

Your next question comes from the line of Gary Spivak from Noble Financial Group.

Thank you very much for taking my question. Can you comment -- we talked about budget flush and the [lack of the service provider space] and a little bit on the Enterprise side. I'd love to hear any color that you have regarding the spending environment in the Enterprise at the end of the year, and how much that contributed to your overall success in that vertical.

Well, we have a relatively limited view of the overall Enterprise spend, but certainly for our kinds of project oriented selling to our large install base, we begin to see some of those projects come to ground. And turn into orders. I think others have seen the up tick in the Enterprise a little earlier, which is typical for us. I think we would say the things that other people may have been saying earlier, we're now able to say, yes, we're seeing the up tick in the willingness of our Enterprise customers to take on new projects and put out new dollars, a willingness that wasn't there a year ago. That's probably the best we can be for you.

Okay. And if you could share anything -- the subject of acquisitions came up. Are you committed to doing a certain size and pay back time in terms of dilution on anything? Is there anything you're willing to share about that?

We have done all kinds of acquisitions in the past. We have done a total of three. One was for technology, one for expansion, and then we did a big one with [Networld Journal], so we are open to any one of those kinds. And we'll look at the opportunity, and if it looks good then we'll not shy away from that, if it helps.

Our objective, of course, is accretive acquisitions. Nothing is accretive in the first week, but accretive acquisitions.

Okay. Thank you.

You bet.

Your next question comes from Gabe Lowy from Mizuho Securities.

Thank you for taking my questions. You are being very demure about these acquisition questions. It makes me wonder about breaking out that expense this quarter or not. A question on the competitive environment, particularly in the Enterprise as you see these projects starting to come to fruition and driving orders. Who are you seeing more of? Who are you seeing less of? Are the dynamics changing? Pricing environment changing with functionality, maybe some functionality being given away? Maybe if you can shed some color on that, and then I'll have a follow-up afterward.

First of all, a lot of the expansion or increase in business in Enterprise was because of the conditions improving in the marketplace, not necessarily a new functionality. But our biggest area of Enterprise is financial. And yes, there is intense competition. But for most of the players in that space, [they tend to be $1 million companies]. There are five, six small players, [private companies], and we do compete with them. And at the same time, a couple of them want to partner with us, also. In the financial area, this is our biggest one. Those are the traditional competitors, are really smaller companies. And the rest of the Enterprise area, which is not really a lot of the growth, there is just traditional competition in companies like Network Instruments and [AugNet]. But in our two bigger areas, financial we have the smaller financial. For the Enterprise we have the smaller players. And -- I know you didn't ask for it -- but on the service provider side, we have [tectronics] and [GDSU].

Second of all, can you drill down a little bit into the status of the partnerships with Cisco and HP? What's going on there? How are you going to market? Maybe shed some light on that. These have been somewhat slow to materialize. There are proof of concepts going on, education going on. [Or that still] needs to happen. What's happening and what needs to happen to start to see these begin to contribute more meaningfully? Thank you.

Let me take that. This is Michael. In terms of Cisco, there are many different facets to potential cooperation with Cisco. The most promising one, and the one that I mentioned in my prepared remarks, is the one associated with our [integrated] agent. There actually, we have made reasonable headway in terms of [ensuring] customer deployments. We are seeing collaboration in the field with Cisco. It's a great way to initiate conversations within the field organizations. And we are seeing quite a number of situations where we are going into the customer jointly. And so, I am confident that the next couple of quarters I am going to be able to report much more material on significant results from that.

Now, with HP, the situation is that we have a similar integration project completed, and we expect that the collaboration will be increasing in the field. But clearly, HP has a much, much smaller installed base. This is basically their [procurve] line where we integrated ourselves, and [we have] the same technology as Cisco. But it also has -- we have a number of other facets. We are working with EDS. And so, we are going to see some results from HP as well in the next year, but it's a slow process. I agree with you. It's a slow process.

And just circling back on Cisco again, you're doing some joint field collaborations going into the market. I presume that you are doing much more of the heavy lifting there, particularly since Cisco sales reps have never had a reputation for being good software salesmen.

That's right.

And this doesn't really move the needle for them in terms of selling [other boxes].

Well, it is actually really one of the very few first applications that they released with the ISR blade. This modular engine that accommodates third-party software solutions for their ISR family. So, we were really the poster child for this new capability. In fact, Cisco did put us into their pilot program on their website. So they are doing the core marketing kinds of things. And we have been important to them simply just as sort of a best -in-class kind of example for the value added that can accelerate ISR sales. Which could be very sizable, because [ideally] we are talking about hundreds of thousands of branch offices in a large installation.

So Cisco will sell the $1500 item a blade in that price range times thousands of routers. And that gets a Cisco sales rep --

(Inaudible) We are going to see some movement.

( indiscernible ) particularly by other products which are not [tied] to Cisco, when we get interviews to those accounts, they particularly buy that stuff, our standard product line, [DM] and (inaudible multiple speakers)

I think, Anil, that might be your sales guys' better strategy. Last question for David. You mentioned talking about acceleration in revenues from fiscal 2011 into 2012 operating margin expansion. Should we be thinking about that long-term model range on the operating margins inching up a little bit from what you've stated? Or are we still looking to be in that range, just at the upper end maybe?

Well, a long-term model is the long-term model until it's no longer the long-term model. So, I can't really tell you about that. But you might have noticed the words in the prepared remarks that said subject to regular review. Those words weren't there a quarter ago.

Thank you very much. Continued [success].

Yes.

Your next question comes from the line of Dan Cummings from Saint Equity.

Thank you. I wanted to ask about -- I guess I call it the confidence in your prepared remarks regarding your LTE products. You referenced expectations of accelerating order flow in Q4 and 2012. With respect to Q4, can you give us a little bit of color or support for that confidence? I'm curious if it's related at all to some of the discretion that the US carriers seem to have won from the FCC recently.

First of all, we can't talk about specific companies, but we expect good traction in this area in the first half. It's very hard to say whether it will be some of these big deals will be at the end of this quarter or the beginning of next quarter. But we think in the next six months or so, if we [gain] in many of these pilots we are engaged in right now, we'll see some decent business.

In terms of confidence for the future, near-term Q4 and beyond, we spent a lot of time looking at our deal pipeline. It's really based on that assessment, both short term, where we look at deals individually, and long term when we look at things and opportunities in the aggregate. That opportunity [SAT], represented by that pipeline, is growing. Therefore, that's the precursor. That's the lead event that lets us believe that bookings, and therefore revenue, will follow.

Okay. Could I just ask a follow-up related to Q4? I'm curious about continuing resolution at the federal level. I think we've got support here through the first week of March for the government to keep spending. Do you need to watch that relative to where you typically sell into federal? Have you had to do any adjustments to the funnel because of that?

It could affect us, particularly on the civilian side. Most of our business is defense. And a lot of the defense business is related to war-fighting efforts or other related defense efforts. So, we tend to be a little less affected by the vagaries of the budget. But no one is immune.

Okay. And last question on bookings. Is there any particular reason looking back that we would not expect to see bookings up year over year for the fourth quarter?

I really can't comment on the specific bookings up or down, but if we're going to grow the way we're talking about, we have to grow bookings .Looking backward, you're asking about the comparables. Bookings a year ago were pretty reasonable. But we have to grow. Put those two things together and take a shot.

Okay. Thank you.

Okay.

Your next question comes from the line of Sanjit Singh from Wedbush Securities.

Just a couple of quick questions. In terms of the customer base, are you signing more new customers? Is there a mix that you can give us between existing and new customers?

We don't report that as a regular stat, but we do focus on new customers. And we have some new customer initiatives in place in the sales force and focus on it. Those initiatives have paid some dividends. Mostly in the Enterprise, although not entirely. In our Tier 2 service provider business, we have a team in place that has was put in place at the beginning of this year to go after new customers to us who happen to be, because of our initial focus on Tier 1, in Tier 2 service providers. They are making progress, that team. So, both in the Enterprise and in the Service Provider, we have a focus on new customers. And it's working.

Great. And what is your view on deal sizes. And when I talk about deal sizes, maybe separate it out between the Enterprise business and the Carrier business. If we start to see some LTE pull through, are those deals potentially larger than what happened in 3G?

Potentially, yes. Although some of the 3G deals were pretty big as we experienced them a year ago and nine months ago. But [potentially, yes. Deal sizes have been trending up for us, not just because of Service Provider, but that's certainly been a major contributor to our deal size expansion .We have deal sizes now that are regularly, every quarter, 50% larger than our deal sizes were two or three years ago. So, deal sizes are expanding. We expect that to continue.

And my last question is this. Did anything have to happen from a product standpoint in terms of technology that you had to do over the past quarter or two to prepare for LTE type wins? I'm thinking about the change in the product.

First of all, we mentioned that we added [or improved] our basic knowledge in the form of ASI. And that [provided] a base for both Enterprise and Service Provider. Most of the LTE product development has happened over the last 12 months. So I think that has been one of the biggest focus areas for R&D over the last 9 to 12 months. That's what makes us ready for the business for the coming year.

Thank you.

Thank you.

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

Thank you. I think there may have been an earlier question on this, but I want to ask specifically about it. For the Service Provider business, have you noticed a change in ASPs over the past few quarters?

Service provider business, as we say, is very lumpy. So if you get a big deal, multiple millions of dollars, that will drive ASPs up in that quarter. If you don't get that $5 million deal, then ASPs come down. So, ASPs are pretty jagged. But in general, ASPs are going up in the Service Provider space. Once you're accepted as an LTE vendor, then deals come, and they're big deals. Even from smaller carriers. They're big deals.

Has there been a change at all in Service Provider deals where you see what was scoped as a large deal opportunity being revived downwards to a pilot size?

No, it doesn't typically happen that way. They don't sort of back up. The competitive pressure on the service providers is too intense. So, if anything, it's sort of the other way around. Things are accelerating in terms of their LTE projects, and pilots are being hurried up. That's putting pressure on us to finish the work that Anil has talked about. But we're doing that. And so, no, we haven't seen anything, basically, de-committed. My words, not yours.

Okay. Thank you.

Okay. Thanks, Scott.

There are no further questions at this time.

Thank you very much. Thank you all for coming. This has been an excellent question session. I think a record length for us, which we appreciate. We are out of time, however. And perhaps out of questions. We look forward to talking with you again at our next earnings call in 90 days or so. I hope you all have a good evening.

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