Netscout Systems Inc (NTCT) 2012 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to NetScout's third-quarter fiscal year 2012 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, Ms. Jean Bua; NetScout's Chief Operating Officer, Mr. Michael Szabados; and Mr. David Sommers, NetScout's Executive Vice Chairman. At this time, I will turn the call over to Ms. Cathy Taylor, NetScout's Director of Investor Relations, to provide the opening remarks. Ms. Taylor, please proceed.

Thank you, and good morning, everyone. Welcome to NetScout's fiscal 2012 third-quarter 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 with you a discussion of factors that we currently anticipate may influence our results going forward. These statements include forward-looking statements made pursuant to the Safe Harbor Provisions of Section 21-E 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 express or implied statements regarding future economic and market conditions, guidance for fiscal-year 2012, acquisition integration success and new product releases.

It should be clearly understood that the projections on which we base our 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 on Form 10-K for the year ended March 31, 2011 on file with the Securities and Exchange Commission.

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 acquired intangible assets, as well as the GAAP effects of stock-based compensation. Our non-GAAP results also exclude certain extraordinary expenses relating to our recent acquisitions, including business development and integration costs, and compensation for post-combination services. We also eliminate restructuring charges and the loss on our extinguishment of debt.

We exclude the related impact of all these adjustments on the provision for income taxes. The difference between GAAP and non-GAAP are disclosed in reconciliation tables in 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. Thank you. I will now turn the call over to Mr. Anil Singhal, our Chief Executive Officer.

Thank you, Cathy. Before we begin a review of the quarter, I want to comment on the organizational changes that we announced during the quarter. David Sommers, our former CFO, has been promoted to Executive Vice Chairman, and Jean Bua, formerly our VP of Finance and Chief Accounting Officer, has been promoted to Chief Financial Officer, succeeding David. David will have the responsibility for corporate development and investor relations. David has been with NetScout for 12 years, and his new expanded role will include (inaudible) with the corporate strategy, mergers and acquisitions, strategic partnerships, and general development.

Jean was hired over a year ago and has demonstrated strong executive leadership and financial management skills. And we expect her experience and expertise to assist us through our next wave of growth. We are very pleased to have a top-caliber executive such as Jean available in the Company to provide a smooth succession by for the critical CFO. David and Jean will report to Michael Szabados, our Chief Operating Officer.

Now to our results. We performed well in the third quarter. We posted record quarterly revenue of $83.3 million, an increase of 15% sequentially and 9% year over year. Non-GAAP earnings per share were up 46% sequentially and 13% over last year. Our third-quarter results are on track for the full-year guidance. As in Q2, we entered Q3 with a material backlog of orders. We are entering the fourth quarter with $13 million of product backlog, and we are reforming and tightening the range of our fiscal 2012 guidance.

Despite an uneven macro business environment, we saw very strong service provider business, basically from carriers in Asia and US, with bookings up 40% over last year and up 33% on a trailing four-quarter basis. We are aware that other companies in adjacent markets have seen a weaker spending environment from telecom service providers, particularly in North America. However, the demand for our product remains strong, as our wireless carrier customers compete to build out the most effective, reliable IT network.

We continue to make significant enhancement to our service provider solutions and to win new business as a result. We are excited to have won substantial new business from a US tier-one wireless carrier with follow-on orders expected next fiscal year. As our US tier-one carrier has indicated that our solution is outperforming the competition and helping them to quickly identify and resolve service performance issues on their LTE network. Our enterprise business remains stable, and we expect to see continued volatility from the financial services sector, but we expect continued growth from financials over the long-term, as they increasingly compete with each other to enhancing the user technology.

Our [garment] business experienced a somewhat-greater-than-normal seasonal decline. During the quarter, we completed our acquisition of Simena, our third acquisition this year. Simena is a leader in scalable connectivity solutions for high performance networks, selling primarily to high density packet flow aggregation switches. Simena's packet flow switches are a logical add-on to our existing product line, since many of our customers use aggregation switching, and this allows us to offer a more complete solution. This new product line will help us meet customer needs and adapt our solutions to high-speed networks, such as 10G Ethernet today and to 40G and 100G in the future.

Our new nGenius1500 series packet flow switch helps our customer include the control and distribution of IP traffic being fed into nGenius InfiniStream appliances, and also allows the packet flows to be fed into other monitoring devices for use such as Cyber Security. We have quickly integrated Simena into our operations, and are already switching the 1500 from our Westford location. We welcome the Simena team and the FoxReplay team to the NetScout family. Thank you for your time, and now I will pass the call to Michael for discussion of additional highlights of our performance this quarter.

Thank you, Anil. I would like to augment on his comments on some performance this past quarter with some details on our sector performance, product plans, and update of the integration progress with our recent acquisitions. During the year, we have been expanding our sales investment in tier to service providers and cable MSO companies, including a dedicated sales focus in the US. This focus has allowed us to gain significant business, and we are experiencing strong growth from these customers. Globally, our nGenius service assurance solution has been purchased and installed by an additional 18 service providers since December 2010, bringing our total worldwide deployment to 148. We believe, based on the informal assessments by industry analysts, that we are the market share leader in IP-based service assurance, or wireless carriers globally. This is no small feat since we entered this market only four years ago.

Our service assurance solution continues to win visionary and product of the year awards from major publications and industry organizations. These awards and recognitions serve as benchmarks of the value we are producing from the investments we have made in development and sales to bring solutions to service providers for their growing dependency on IP-based networks.

In the enterprise, the financial sector continues to be our largest market, as they focus on IT innovation to create competitive advantage. Our bookings from this sector are principally driven by repeat business from our install base, but we are also succeeding in leveraging our expertise in this sector to win new customers worldwide, particularly in Asia. Results from the government sector this quarter slowed as expected, especially after a very solid performance last quarter, which was the last fiscal quarter for the federal government. Looking forward, we see continued growth opportunity for government, particularly with our new product offerings in video and voice management, packet flow switch and Cyber Security.

On the product front, we see continued growth in our existing service assurance offerings and growth in demand for our new product offerings from acquisitions and new announcements. Of particular note, this past quarter were major enhancements to our service assurance offerings for wireless service providers evolving their networks to LT or 4G technologies. In addition, product integrations from our FoxReplay acquisition in the Cyber Security space, from our Psytechnics acquisition in the UC space, and from our Simena acquisition in the packet flow switch space, are proceeding well and are on track. I want to thank you for attending our call today, and I would like to turn the call over to Jean.

Thank you, Michael, and good morning, everyone. As Anil outlined, our business produced solid results for the third-quarter of fiscal year 2012. During this quarter, we acquired technology through our Replay and Simena acquisitions, adding session reconstruction and analysis and packet flow switching to our product line. We also refinanced our credit facility, providing us with greater liquidity and flexibility. As a result of our year-to-date performance, we are reaffirming but tightening our annual guidance range. For the third quarter, our results included revenue of $83.3 million, which is an increase of 9% from the same quarter in fiscal year '11. Product revenue was $46 million, an increase of 7% over the same quarter prior year. Service revenue was $37.3 million, which is an increase of 12% from the same quarter in the prior year.

On a non-GAAP basis, our earnings per share for the third quarter were $0.35. This is a $0.04 higher than the third quarter of FY '11 and represents a 13% increase. On a GAAP basis, our earnings per share were $0.24. Total bookings in Q3 were $82.8 million, up $2.8 million, or 4% year over year. New business bookings were $57.4 million, up $3.2 million, or 6% over the prior year's third quarter.

The components of our new business bookings for Q3 FY '12 were as follows. Enterprise was 55%. Telecommunications was 32%. Government was 13%. Within the enterprise sector, the financial services subsector was 24%. This compares with the prior-year quarter's components as follows. Enterprise was 63%. Telecom was 23%. Government was 14%. And within the enterprise sector, the financial services subsector was 26%.

Summarizing large deals for the quarter, 166 customers gave us orders of over $100,000, which is consistent with last year. 25 customers gave us orders over $500,000, in comparison to 35 customers from last year. We received 10 orders over $1 million, of which 5 came from telecommunications, 1 from financial services, 2 from government, 1 from the energy industry, and 1 from healthcare. This compares to 15 orders over $1 million that we received last year in Q3. Last year's orders greater than $1 million included 5 from telecommunications, 4 from financial services, 2 from government, 3 from healthcare, and 1 from manufacturing. Service contract renewal bookings in the quarter were $25.5 million, which is consistent with the prior year.

Turning to other revenue-related metrics for the quarter, revenue contribution from direct customers was 42%, and reseller revenue was 58%. Revenue from international sales was 27% of total revenue, as compared with 31% of total revenue for FY '11. Within our international sales, Europe delivered 11%, as is compared to 17% last year. Our Asia sales percent was 6%, which is consistent with the prior year. Other international sales were 10%, as compared to 12% from last year. Product backlog at the end of Q3 was material. We are entering Q4 with product backlog and deferred product revenue of $13 million. Total deferred revenue was $95.1 million, which is an increase of $1 million from last year.

Additionally, for the third quarter of FY '12, the business had strong gross profit and operating margins. On a non-GAAP basis, our gross margin was 81%, which is up 100 basis points from the same quarter prior year. For the quarter, our non-GAAP gross profit was $67.5 million. Our GAAP gross profit for the quarter was $66 million, and GAAP gross margin was 79%. Our non-GAAP operating margin for the quarter was 29%, which is a 300-basis point increase from the same quarter prior year. Our operating margin expanded, even as we integrated two new companies as we experienced strong revenue results this quarter, while continuing to focus on our cost-management initiatives. Non-GAAP income from operations was $23.8 million. GAAP income from operations was $17.4 million. GAAP operating margin was 21%, consistent with the previous year.

The major differences between our non-GAAP and GAAP income from operations for the quarter is the exclusion of stock-based compensation for $2.2 million, and about $4 million of costs associated with our acquisitions, which includes amortization of intangibles for $1.8 million and business development expenses totalling $2 million. These are detailed in our reconciliation of our non-GAAP to GAAP results presented in our press release. Non-GAAP net income was $14.8 million, or $0.35 per diluted share. The non-GAAP net income after-tax margin was 18%, which is up 1 point from a year ago. GAAP net income for the quarter was $10 million, yielding earnings per diluted share of $0.24. GAAP net income after-tax margin was 12%, which is a decrease of 3 points from a year ago.

The quarter's provision for income taxes is recorded based upon a full-year effective tax rate of 34.9% on a GAAP basis. Our GAAP tax rate for the quarter is 38.2%. Consistent with past practice, we have used the statutory tax rate of 38% to tax effect the non-GAAP adjustment. The adjustments reconciling our non-GAAP results to our GAAP results are summarized in the reconciliation table included with our press release.

On a year-to-date basis for the first three quarters, total revenue was $219 million, which is a 3% increase over the first three quarters of fiscal 2011. Product revenue was $113.6 million, which is consistent with the prior year. Service revenue was $105.8 million, representing an 8% year over year increase. Year-to-date, total bookings were $224 million, up $22 million, or 11%, over the prior year. New business bookings were $163 million, up $12 million, or 8%.

Our enterprise and service provider verticals experienced overall growth from the prior years. Our service provider sector grew 34% on a year over year basis, which was helped by our investment in expansion to service providers on a global basis, as well as LTE deployment from the major global carriers. Our enterprise sector increased 1% overall, despite this vertical, including the financial business, which decreased by 7%. Our government vertical decreased year over year by 2%. Within this sector, our federal government business decreased 5%, while the rest of the government business, which includes foreign governmental agencies and state governmental agencies, increased 5%.

We continue to maintain strong liquidity. At the end of the quarter, we have invested cash, short-term marketable securities, and long-term marketable securities of $192 million. Cash and short- and long-term marketable securities at the end of our fiscal year 2011 was $228.5 million. Following our cash deployment priorities, the decrease in cash and securities is the result of purchases of Psytechnics, FoxReplay, and Simena. Additionally, we purchased 1.3 million shares under our share repurchase program this year.

Free cash flow for the three quarters ending December 31 was $36 million. In November, we entered into a credit facility, which provides the Company with a $250 million revolving credit facility, which may be increased to $300 million at any time up to 90 days prior to maturity. On the same day we drew down $62 million to repay our existing indebtedness and issuance fees under the new credit and security agreement. Our liquidity at the end of December 31 was $380 million. The facility has a term of five years and matures in November 2016. Our pricing is tiered and based on our leverage ratios. Our current leverage ratio is less than one times debt to trailing 12 months EBITDA, so our current pricing is 125 basis points over LIBOR.

Accounts receivable net of allowances was $49.6 million, down from $49.7 million last quarter, and down from $57.8 million a year ago. Day sales outstanding were 54 days for the quarter. This is down from our second quarter of this year at 62 days, and down from 68 days last year. Inventories were $9.4 million. This is a $400,000 increase from our second-quarter levels, and is a $500,000 increase from the third quarter of fiscal 2011. Inventory turns were 3 times for this quarter, versus 2.4 times for our second quarter, and 2.6 times versus the third quarter of fiscal year '11.

We are reiterating fiscal 2012 guidance, but narrowing it with one quarter remaining. GAAP and non-GAAP revenue is expected to be in the range of $305 million to $310 million. GAAP net income per diluted share is expected to be in the range of $0.74 to $0.78, and non-GAAP net income per diluted share between $1.07 and $1.11. The GAAP net income per diluted share range has been adjusted to account for recent acquisition activity. The fiscal year 2012 non-GAAP net income per diluted share expectation excludes the purchase accounting adjustment to fair value of approximately $300,000 for deferred revenue; forecasted share-based compensation expenses of approximately $8.6 million; estimated amortization of acquired intangible assets of approximately $6.6 million; business development integration costs of approximately $4.3 million, which includes costs associated with the integration of Psytechnics, FoxReplay and Simena; compensation for post combination services of $300,000; restructuring charges of $400,000; loss on debt extinguishment of $700,000; and the related impact of these adjustments on the provision for income taxes of $7.3 million. Our long-term operating model remains unchanged.

That concludes our financial discussion this morning. Thank you for joining us. We look forward to taking your questions. Sarah, we will now take your questions.

(Operator Instructions) And your first question comes from the line of Mark Kelleher from Doherty & Company. Your line is open.

Congratulations, good quarter. Was wondering if you could talk a little bit more about the carrier business. You had touched on that with your commentary, but definitely some different buying trends and different companies seeing some different things. Can you give us the priorities that you're seeing the carriers focus on in terms of their CapEx spending?

Overall, I can add a few things. I don't know (inaudible) a little bit about the specific orders this quarter, but I think we continued to see, as we had mentioned in the past, that a lot of interest in LTE deployment area and with all the tier-one providers, especially in the US, but also in Asia-Pac and Europe. And while there is a lot of investment in LTE, there is a lot of reinvestment, or additional investment on the 3G side also. So having a good LTE solution, or a more complete LTE solution, competitive solution in the market also helps us sell into other parts of the network, which are not necessarily LTE. So I think that's -- as we mentioned in the past again that at various parts of the network is moving to IP, including the access network. I think this opportunity will continue to grow with the traction we are having with tier-one providers.

Just one other point, there continues to be an expansion into tier-two worldwide, especially in Asia, and also tier-two in the United States, so there is a continued growth source for us.

Okay, that's helpful. Thanks. Then just a quick balance sheet question. There are some contingent liabilities on the balance sheet. What are those?

When we did some of the acquisitions, we have payments, long-term payments associated with the purchase price of those acquisitions related to some of the [founder's own] employees who will be staying with us on a long-term basis.

Okay, great. Thanks.

Your next question comes from the line of Alex Kurtz from Sterne Agee. Your line is open.

If I look at the product year-over-year growth, I guess you did about 7% this quarter, can we think about you being a 10% type of product growth Company year-over-year on a go-forward basis? Not necessarily for fiscal '13, but in general, do you believe that you can grow north of 10% for product revenue?

Yes, actually, we will be providing guidance next quarter, and then you will see exactly what we are forecasting or what we are looking for next year. But yes, we are -- a long-term model is beyond 10%, and we actually need to grow as fast as total growth on the product side. So, yes, we are looking at double-digit growth in the future, and we will give specific guidance next quarter.

Okay, and Anil, just to follow up on the prior question, because I think a lot of people saw Juniper with some weak results last week, and I think everyone tried to correlate that to anyone with TELCO exposure. Is it just that data management analytics, it just maybe has a higher priority than maybe some quarter routing and infrastructure spending inside these TELCOs? Can you just give us a little bit more of a view about how your products differ, versus something you may see from Cisco or Juniper, and why you did so well in the quarter?

First of all, I think quarterly, the results are not a good indicator of the trend for the whole year, and because of lumpiness in all those one or two orders, it can make a big difference for us and to one quarter versus another. So I don't know whether it's just that trend these other players are seeing, or Juniper or Cisco have it just too big for them. They have some budget implications because of the size of the deals they are doing. But for us, I look at it, yes, management continues to be very important and especially for service provider. They are used to investing in analytics and [basic] monitoring the kind of products we do. And we don't really need to sell them on the value proposition. We have to just win competitively. So, yes, we are seeing that effect, but I would -- won't look at just one quarter result as a trend, necessarily as a trend that we are doing better than others.

Your next question comes from the line of Chad Bennett from Craig-Hallum Capital. Your line is open.

You talked about a new business win with a tier one this quarter, an order you received there. Maybe this is piggy-backing on other people's questions on figuring out this carrier stuff. But at what point are they, or were they in the decision-making process when they actually, when they got over the hump and actually purchased your solution? Was it in terms of where they were in building out their network, or problems they were already having in an LTE portion of the network that was already built out? Can you give us an idea of when they made that -- and not saying this carrier, that there's a template for the rest of the carriers, but how they made that decision and the timing, as much color as you can give?

Yes, basically it's a combination of things. Whenever you get a big deal, it's for multiple reasons and multiple parts of the network. And sometimes, some big problem, which got addressed by some of our previous product [drives] obviously. This tier-one customer was an existing customer, and -- but otherwise, as they're building the LTE environment, they are having allocating budget for the instrumentation of management portion also. And so it's a combination of both the things that are there, some pressure on some existing problems, something rarely happens recently, and which acts a trigger point or urgency through (inaudible). But overall, it's all part of the LTE deployment process.

Okay, and this was the initial order from this tier-one for LTE, or did they order some product previously?

They have been a customer for a long time, but not necessarily for LTE.

For LTE, okay. And then secondly, it looks like the new bookings from the enterprise segment were actually down about 8% year-over-year, and I know you at least qualitatively talked on the call about you expect enterprise bookings to grow and -- but maybe be volatile on the financial service side. I'm just trying to understand a little bit more detail into what's going on there. And then maybe you can speak to the competitive environment on the enterprise side, and if anything's changed.

Yes, nothing has changed on the competitive environment. In fact, we are doing better than others, but there have been a lot of budget issues on the financial side. At the same time, the acquisition which we did will do help more on the enterprise side next year. So that's why I think we feel bullish about the growth of the enterprise business, because all of the acquisitions we did are very relevant, are going to be relevant to the growth on the enterprise side.

Let me just add something. We continue to see the trends that we've talked about in the past in the broad enterprise, with financials struggling a bit as they go through, some of them individually, go through their restructurings, which continue. And the rest of enterprise generally being better than that. And that trend continues, and we expect it to continue until the financials come out of malaise, which is not going to last a lot longer in the future. It's a little hard to predict exactly when they will end. But barring a calamity in Europe, we would expect our major financial customers in fiscal '13 to have a much better buying outlook than they have had in the recent past.

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

First, some flavor for how much revenue from acquisitions.

Well, as we spoke about that, first of all, it is too early to tell because some of the things just got (inaudible) less than a quarter ago. And as we mentioned and I talked about in the past, we will not be providing that information.

No, I was just talking about in the quarter you just reported.

Yes, even there, I think the problem is that our product is very closely integrated. For example, we sell, InfiniStream is a big portion of the revenue, and that could be sold because of a competitive product -- because of the acquired product, like in the voice area or for trading application, or both. So not only -- we decided not to report it, including this quarter as well as next year. But it's just very hard for us to separate the revenue and find out the exact reason why because of acquisition or some other reason.

Can you comment on linearity and whatever else brought DSO down?

The DSO is mostly related to SKU. How much of the backlog from the prior quarter shipped in the beginning of the quarter. So it's more a function of the flow of orders and how we shipped them, rather than anything else in particular.

So it's linearity, year was more front-loaded in the quarter then?

Yes.

Now, deferred revenue shifted -- actually before we get off that topic, was it more than 30% of your sales in the first month?

Well, if you think about the flow of the backlog from Q2 into Q3 and how that would ship, and then the backlog that would built up on the end, I don't have a graph of how it came in, but the phenomenon would be more that we shipped the backlog from Q2 earlier in the Q3 quarter than what we would have done normally on the quarter.

Should we expect the DSO to come up significantly this quarter?

This quarter generally is a strong quarter. If it follows previous patterns, I would imagine it would be slightly better, depending on how much of the backlog was used and continued at the end of the quarter. If not, I would just expect it to be continuous with prior -- with the same fourth-quarter DSOs as in prior years.

And the deferred revenue shifted more towards current. Any commentary on why that occurred?

I think -- I'm sorry?

I was wondering if maybe you had a smaller percentage of multiyear maintenance deals.

Well, we have the large multi maintenance deals that would have happened in FY '10 into -- pulling it from FY '11. Other than that, any particular trend or anything like that in the deferred revenue, there was nothing that comes to mind.

Can you give us the CapEx depreciation and change in head count?

The depreciation for the quarter was $2.3 million. CapEx for the quarter was about $2 million also, just for the quarter. And the change in head count, change in head count ending -- we had 872 total head count at the end of December, and we had 869 total head count at the end of September.

Should we expect head count to stay flat going forward?

Probably, yes. The change between the two quarters clearly would be the employees that came to us through the FoxReplay and the Simena acquisitions.

Right, okay. So you're basically not hiring it doesn't sound like. Is that the right assessment?

Yes. No, we will be hiring, but mostly in sales at this point. So there will be some increase in head count, but not dramatic.

Have you done -- on the enterprise side, are you doing anything to address the competition coming at you from below, anything new there?

Well our strategy has been -- if you're talking about below being the price, and we always had that. And our strategy is to put more and more functionality. As I mentioned earlier in answer to the previous question, InfiniStream, which is basically the instrumentation product is where a bulk of the revenue is attributed to, even though we sell that because of the application that is voice-video data. So a lot of the competition comes in that area in terms of price, but since we can't -- our devices are multifunction device, people are -- can buy one device for four or five functions. And with this acquisition, we are adding the Cyber and unified computing to the picture. And so the effective price for the customer, as well as some unique ASI technology we have which reduces the -- increases the power of the hardware at the same price, it allows us to compete from people below, even though their price could be much lower than ours.

This LTE tier-one deal you mentioned, is that a situation where you're moving from more of a core of the customer towards the edge, or is the customer -- or is it a different scenario?

Yes, well, there is -- we are moving core towards a little bit on the access side, but there is still more opportunity on the radio access network side, which is moving to IP also. I think it's still very close to where we were on the core packet core side, but we start seeing some traction on the access network side also for LTE.

Your next question comes from the line of Dan Cummins from ThinkEquity. Your line is open.

First, I wanted to ask about the results in Europe down year-over-year, and whether you are shifting resources to the Asia region? You mentioned decent results from service provider and financial services in Asia. And I had a follow-up about carrier IT spending versus network capacity spending. Thanks.

On Europe, we definitely are seeing the effects of the economic malaise, and the general -- in the financial segment in particular. So Europe is continuing to be a challenge, but not across all territories. And we believe that there continues to be opportunity in Europe. So we are not basically -- we're not changing our commitment to Europe. On the other hand, new investment will probably be rated towards Asia more so than in Europe. But we believe Europe will recover and we'll continue to stand by to capture that opportunity. Your second question was?

You're doing very nice volume of smaller deals here to produce these results. It's really, it's real excellent improvement on the sales function overall. My question is, there seems to be a real dichotomy out there between exposure to network capacity spending and network evolution, as opposed to the carriers' spending dedicated to the carriers' internal IT function, improving it and related business processes. Are you -- as an ATM vendor, are you able to plug more, relatively speaking, more effectively into the IT budget, as opposed to the network budget right now? Thanks.

We are more and more selling -- biggest portion of our revenues coming from the customer-attached portion of the network, not the internal IT network, if that's the question. That said, internal IT is a very, very small portion of our carrier business.

So the service provider results that you're seeing right now, are you really -- are we on the cusp of something very large and significant in the US with respect to 4G and LTE? Is that really the take-away here?

It is -- it's driven by LTE, but not necessarily all the money is coming from -- budgets are not LTE-related directly. But having a successful product on the LTE side pulls in the non-LTE business also. So LTE is a big driver, but not necessarily all budgets are associated with LTE. But in either case, just to add to the previous question that almost all of our business is coming from the customer-attached part of the network, which is revenue producing.

If I can add one thing to Anil's observations, we've said in the past that we think there are 600 target service provider customers, of whom 300 we know have approximately have LTE plans in place now. And about 30 of them are actually executing anything. The LTE wins that we continue to talk about, both in the US and in Asia and in Europe are participating in that 30, right, of whom we have a significant proportion. There is obviously a lot more potential here, although the biggest opportunities clearly are the US tier-one carriers to whom we're selling. So if your question is, "Are we on the cusp of something significant," we think we are. That doesn't mean it's a straight line up from here. There will be lumps and accelerations and slow downs, but we're very excited about the potential that we have in the carrier business, driven, in large part by LTE, but also by other spending, as Anil has said.

Your next question comes from the line of Aaron Schwartz from Jefferies. Your line is open.

As you continue to gain traction in the service provider vertical, does the revenue mix shift change there at all? Are you going to be required to have more services folks involved in that, or are the carriers doing all the implementation and services work on their own?

We have I think -- mix is not really changing -- people are using -- we already have from a services point of view, we have our big account [a person on site for support] and services and everything. So, yes, mix is not changing, but there is a service element to it, but it's being performed by our own team rather than outside professional services.

Okay, and I don't know if you disclosed this in the past, or I don't know if you're willing to, but can you give the approximate professional services revenue within the services? What's the maintenance verse pro services split in that number?

We don't have a significant ProServe revenue stream. We've actually integrated our ProServe organization into the sales organization to provide better close-in support, in part to address the issues surrounding your first question. Although we have a residual professional services revenue stream, it's not material. So you should consider our services revenue stream, it's 95% plus maintenance revenue.

Which includes premium services, which is a half-step between professional service and typical support services, so we have people on site who are really partly operating the equipment and partly supporting it. So there's a continuum, but it's not a significant source of that revenue service.

It is, even with premium services, it's annual contracts that are ratably recognized -- where revenue is ratably recognized. It's not hours or days of consulting. That's the way you should think about it.

Okay. That's helpful. Switching gears a little bit, I think you spoke about this a little bit in December, but you did some internal redeployment of sales to some higher growth opportunities. And wanted to get an update there. Obviously, the numbers were good here in the quarter. Is the pipeline build for some of that redeployment still to come, or did you actually see productivity around that redeployment in the period?

Well, we haven't done a redeployment in the sense that you may be contemplating, or we may have miscommunicated on that, if that's the impression we left. What we've done is with new hires, we have been focusing, of course, on the high growth sectors. And that's typically outside the US and in service provider. Michael talked about our tier-two focus in the US with a dedicated group. And we have over the last year or more focused resources there, as well as in Asia and Latin America and elsewhere around the globe, mainly focused on the burgeoning service provider opportunities that we've talked about. So we have done that. That doesn't mean that we've taken resources off our enterprise-focused business by shifting people around. It doesn't mean that.

Okay, and last question for me, if I could. You talked a little bit about the continued sales hiring. Should we expect, or can you -- I know you don't want to talk too much about fiscal '13, but would you expect the sales hiring in '13 to be maybe greater or less than what you've done in '12? Can you provide any color onto that?

Yes, we expect that we're going to be moderate in our sales hiring in order to fit with our financial plans. But we expect sales hiring to continue as we need to invest in these new opportunities, particularly global and service provider opportunities that we have been investing in this year. And we will continue to do that, perhaps at a slightly higher rate than this year on a net basis. However, we haven't finished those plans for this year yet, for fiscal '13 yet. So that's a current view that remains to be confirmed.

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

A couple questions, one, you referred to a second tier one that had some positive comments. Maybe it's obvious, but does this improve your confidence in winning that new business there? And if you can narrow down what you think is the timing of that?

Well, this -- so as we've said in the past, Gary, many of our tier-one positions at this point are joint positions with a competitor, a legacy competitor that's been a management vendor to these tier ones for many years before we even got into business, the service provider business. And so, but we have been participating, particularly as they shift toward LTE. What that comment in the prepared remarks was about was success we've had at a US tier-one vendor, where their experience with our competitors' product in solving some of their LTE problems was less good than their experience with ours. And obviously as that continues, which we believe will be the trend, where we have a joint position with these tier-one carriers. As they see that we are better able to solve some of the sophisticated questions that they are going to run into with LTE, we will benefit from that going forward. Now, this particular carrier we've been doing a regular business with all along. So, this is just a validation point of the value that we can and have been contributing to that carrier.

Okay, thanks, David. And then maybe to shift gears a little bit, did you guys see any component supply issues due to the conditions in Thailand? If so, how did you address it?

Well, we definitely would have been impacted, had we not been able to secure a significant event to buy immediately in the wake of the floods in Thailand. And so we have basically secured our supply well through the middle of the year. And we believe that we are safe from both a pricing standpoint, price-pressure standpoint and eventually a (inaudible) standpoint.

Your next question comes from the line of Ben Rose from Battle Road Research. Your line is open.

I would like to drill down, if I could, a little bit on the enterprise business. I know you quantify the level of business from financial services, but were any of the other industry segments meaningfully different from what you've seen in the past? And then I had a quick follow-up.

So our enterprise business has not been characterized by significant variations among the sectors that are, when I say significant, as Anil points out, in any one order, sector can be higher or lower. But if you look at it broadly overall, it's been pretty consistent. Now, we expect that over time, as some of these nonfinancial enterprise sectors start to do what financials have done for some time, which is to compete with each other for their own, in their own customer-facing businesses, using their infrastructure, their technology, that will drive them to be more intensive buyers of management products like ours. And we would expect some customers that we would benefit from that. But those things are still, I think in the offing. One of the sectors that we have talked about in the past as a potential sector heading down that path is retail, with location-based services putting more pressure on their infrastructures. And we see signs of that in the marketplace, but not yet signs of that in our customers' buying patterns.

Yes, and just to reiterate, the enterprise new business for the year-to-date, the first three quarters of FY '12 over FY '11 was actually up 1%. It's the financial subsector in there that was down 7%. All of the other various categories, as David had talked about in the past, like telemedicine or retail or anything, did experience growth on first three quarters over the same period as the first three quarters of FY '11.

Okay, and then a question on the government business. Could you quantify to some extent the percentage of the business as coming from defense-related departments, either civilian or military within the overall defense budget? And what's your six to nine-month outlook is there, given some of the recent developments in terms of government spending cuts in that particular area being proposed?

Sure. So Ben, we don't actually classify and count our US federal government business between defense and nondefense. Much of our business, the majority of our business, however, is in defense. And regarding the future, it's really hard to say how the balance of the trends is going to come out. Clearly, there's a trend for lower defense spending, lower government spending, at least less fast growth in government spending in the US going forward, and probably lower defense spending as we read the same headlines that you read.

But underneath that trend, it is clear and logical, even if defense officials weren't talking about it, that the spending on technology will suffer less or may not suffer at all. In fact, it may actually grow to replace technology with more expensive ways to project power. How that balance plays out is anybody's guess at this point, I think. But we're certainly on the right side of the equation with government spending, the side of greater efficiency and speed and effectiveness and helping to manage that. So we would expect that we will come out well in relation to other spending in defense. But that's -- but where the bottom line is in all of that is hard to predict.

Your next question comes from the line of Kevin Liu from RB. Riley & Company. Your line is open.

Just a couple questions on the service provider side, one, if you could speak to any design wins you may have had within the quarter. And beyond that, for some of your more mature LTE wins there, I'm just wondering how penetrated you feel you are with those customers and whether you're actually seeing deployment outside of that, or broadly across the network.

I think we are still in the early stages of penetration, like David said. The majority of the service provider, even tier two, are looking at LTE. But in terms of the design win, the one we talked about at tier one was a design win. So I don't know whether you had any specific question on that. So all the business are big wins, but tier one are design wins against the competition.

And with the acquisition of Simena, how does that expand the opportunity you have with these service providers? You guys are already winning some pretty sizable deals. Should we assume it's just a small fraction of that, or is it fairly sizable?

It could be a small fraction of that, but it could be significant. Like I said, we just started shipping that, so I don't think there will be much impact this year. But next year, we should see big impact. But equally, it's not going to be service-provider specific. We're going to see equally big impact on the enterprise [factor] financial across the board, because that's a more efficient way of Simena product, the [FS-based] products are a more efficient way of connecting the instrumentation to the network.

Got it. And in terms of some of these larger size deals, especially over $500,000, that's been down both year-over-year and sequentially. Is that where the pipeline sits today, or is that a function of some of the broader macro issues, and maybe customers wanting to scale some deals down?

I don't think it was the result of downsizing of deals, although deals get upsized and downsized in the selling process all the time. I wouldn't say we saw a greater impact of that. I think it is an artifact to some degree of the pull-forward that we had in Q2 where there were some larger deals that got booked then and might have been booked otherwise, except for our sales incentive programs that we mentioned last time might have been booked in this quarter. But I think on the whole, and someone said it earlier, having a broader base of smaller deals is a healthy thing. We continue to be in service provider, a large-deal-focused business. So having a good base of smaller enterprise business flow is, we think is a very healthy thing. I hope that helped.

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

I don't believe it's been asked earlier, but could you talk about the product backlog, and were you anticipating that it would be up quarter-to-quarter and added to quarter-to-quarter?

Well, we don't really talk about expectations for the backlog. We have said, Scott, that it is our intent to continue to carry a backlog, because it's a healthy thing for the business to do that. But obviously -- I don't mean to tell you the outlook, painfully obvious, but it depends on us being able to generate the bookings to support the backlog plus the revenue growth, and we make that judgment on a quarterly basis. But it is our intent, would be our desire to continue to carry a healthy backlog.

Okay, and then the new service assurance strategy that you've been discussing with us, could you give us any color about how that might be changing the deals in the field, whether it's the length of sales cycle, the deal sizes that you're putting in front of people? Could you give us some initial color on how that's impacting or changing sales at all?

So far, it's not been effective in any appreciable way, but we obviously expect that there will be reduced time to close and the deal sizes will be bigger, and we'll be able to attract new customers with this new USDM strategy, which we went over with you last time. So I -- we see a lot of positive impact in all these areas because we will be the only Company which has a broad enough solution ranging from enterprise to service provider to voice and data to security and performance in a single integrated solution. So we see all those positive things coming to us because of those reasons in the next year.

Your next question comes from the line of Rohit Chopra from Wedbush. Your line is open.

Three questions for you, the outages at one of your tier-ones, they have a dual source, as you said. Are they delaying any of their spending as they try to figure out what's going on over there, or are they increasing spending with you, seeing that you're helping a little bit more with the problem?

So they don't react that quickly. When issues come up, they deal with what they have got. And the good news is, we hear they are dealing more with us and what they got from us. That's good news for the long-term for us. But it's too soon to say that's going to result in anything, it resulted in anything last quarter or didn't, or will result in anything next.

But it will help in general.

But it is positive. The direction is correct.

The outages happened three times at that carrier, and it didn't seem to have been resolved the first time, the second time, the third time. Is that a deficiency that you guys are addressing in your product, something that maybe you could fix in the future or help them correct something in the future a little bit faster?

Yes, we are trying to -- first of all, I think what David, what we are talking about is not necessarily what you're talking about, three outages, and providers. You're talking about -- but we are -- what we mean by that we are able to solve problems faster than other people, and we can give you the early warning system because of our ASI technology prior to users start complaining. So even if it is not an externally visible outage, it's very internally visible when we are able to solve problems faster than the competition, so that's what we were talking about. I'm not sure whether it was directly visible outside, but definitely internally it was very visible that we are able to do a better job than the competition.

And we don't talk about our customers' performance problems, as you would expect.

All right. And I want to ask you quickly, everyone's asked a lot of carrier questions, but are you seeing any changes in the carrier sales cycle? Is it status quo, increasing, or decreasing?

I think it's pretty well status quo. We do see once we have established a pattern with carriers, which with the two tier ones that we've mentioned in this discussion, we have, that the sales cycles tend to be shorter. They buy irregularly as their, because of their aggressive deployment requirements. So that does shorten the sales cycles, but that's not new. The thing that is continuing for us is that we continue to get more wins and establish that pattern with more carriers, and that overall, will shorten our aggregate sales cycle. But it's not -- the carrier's cycles aren't changing. It's just that there's a greater -- we're getting greater penetration and greater concentration in our overall business.

Okay, and last question just on Psytechnics, is that doing better than you expected when you originally purchased it back on April 1? And what are you doing in the channel to improve sales? It seems like a more enterprise-focused UC product. How is it doing so far, and what are you doing in the channel?

It's doing really well, pretty well and pretty much in line with our expectations. And there is no real new channel implication at this point. We haven't really turned on our channels for this. It may become more suited for some of our key channel partners, but that has not yet been the pattern. So it's been pretty well along our plans and expectations.

Your next question comes from the line of Ben Abramovitz from Kaufman Brothers. Your line is open.

Thank you. Good morning. I think a few people have alluded to earlier trying to understand the business environment throughout the quarter in terms of how it is trending from beginning to end in terms of did you see any change? And then I have one follow-up question around bookings.

We didn't see major shifts, Ben, in the climate during the quarter. I will tell you that our insight into how things are going in the quarter is often backend loaded, because our quarters are often backend loaded. And so, we went in with backlog, and that's obviously takes a lot of uncertainty out of making any particular quarter, which is why we try to carry it. But it -- there was neither a deterioration or a pickup from what we had expected. I think the government business was obviously weak, but that was expected. Financials were also slow, and that was also expected. Service provider was strong, and we expect that to continue. So no trends that we can help you with, unfortunately, in terms of the second derivative of what's going on with those business sectors.

You did say you expect the financial malaise to lift in the coming fiscal year, and what gives you confidence, or what are you seeing that at least raises your confidence around that malaise being lifted in the coming fiscal year?

Well, this is perhaps a personal opinion rather than a Company opinion. But the financials have been going through this turmoil for some time. There isn't, absent the European spill-over, there isn't really anything new in what they have been doing. They are going through a process that's been forced upon them by the financial crisis and the new regulations, but it's one that they have seen coming, and they are working through it. And we've said that before. So they will work through it, and the question is when will they work through it well enough to start to come back and focus on driving their business, as opposed to restructuring their business. And that's anybody's guess, but I think it's going to happen next fiscal year personally. What do you think?

Well, we'll leave the David opinion as the last word on this call. We can talk later offline.

Okay.

So my second question was related to bookings. Bookings were up 4% year-over-year. Service contract renewals were about $25.5 million. If we look year-over-year, if you remember -- I'm sure you remember, last year, there was about a $5 million impact to the service contract renewals, because two years ago, because of incentives, your salesmen went out and sold two-year contracts into the market rather than the traditional one year. So if we made that adjustment last year, it would have bumped the service contract renewals up to a little over $30 million during the third fiscal quarter of 2011. And so, when I look at that with the adjustments, it's a little bit down year-over-year. And I'm trying to understand what some of the push and pulls are, or what you didn't see come back on those contract renewals. If it's a product cycle that's ending or something else that would make that actually be down a little bit year-over-year.

Nothing of those things -- you're right about your analysis, yes. There was a -- we pointed out a net $5 million swing a year ago that bumped up the prior years and lowered a year-ago's numbers. And some of that persists to the extent that they were more than two-year contracts that were done two years ago. We did have, and this sometimes happens to us, several large renewals that didn't quite close this quarter. They will close. They always -- big renewals always do. But, so we think for the full year, our renewals will be fine. Our renewal rates haven't declined, and so we are sanguine, we're confident in our overall renewal business. So the message is you shouldn't look at this one quarter as a [nil set] in a different context earlier and try to conclude something about our services business. You really need to look at it year-to-date and on a rolling basis to see the trends are still positive for growth.

And your last question comes from the line of Gabe Lowy from Mizuho Securities. Your line is open.

Good morning. There is no last question. They have all been exhausted. Thank you.

Okay, Gabe. Thank you very much. Well, if there are no further questions from all of you on the phone, we'll thank you very much for your time and attention today and your very good questions that were exhausted, or exhausting, whichever you prefer. We'll see you again in 90 days.

And this concludes today's conference call. You may now disconnect.