Netscout Systems Inc (NTCT) 2013 Q3 法說會逐字稿

Welcome to the NetScout third-quarter of fiscal year 2013 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 this 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 Operating Officer, Mr. Michael Szabados, and NetScout's Chief Financial Officer, Miss Jean Bua.

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 2013 third-quarter conference call for the period ended December 31. Before we begin let me mind 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.

These statements include 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 marketing conditions, guidance for fiscal year 2013, 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 discussions 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, 2012 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 on a non-GAAP basis. Our non-GAAP results eliminate the GAAP effects of our acquisitions by adding back revenue related to deferred revenue revaluation and removing expenses related to the amortization of acquired intangible assets, the GAAP effect of stock-based compensation and restructuring charges.

Our non-GAAP results also exclude certain expenses related to our acquisitions including compensation for post-combination services and business development charges. We exclude the related impact of all of these adjustments on the provision for income taxes.

The differences 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.

We have included on today's webcast a slide presentation that provides a summary of key financial data that accompanies the financial section of today's discussion. For those listeners who have dialed into the call this morning and would like to view this presentation, you can find it by going to our website at www.NetScout.com/investors and then clicking on today's webcast. I would now like to turn the call over to Mr. Anil Singhal, our Chief Executive Officer.

Thank you, Cathy. We are very pleased to report another strong quarter in fiscal year 2013. Q3 non-GAAP revenue grew 10% to $92 million while our non-GAAP earnings per share grew 3% to $0.36 for this quarter compared to the same period of the last fiscal year. Jean will discuss our third-quarter comparison in more detail later in the call.

Looking at the results of the first three quarters of our fiscal year we have made good progress against the goals we set at the beginning of fiscal year 2013. On a year-to-date basis we achieved 15% revenue growth over last year while our credit product revenue grew by 22%.

Another successful benchmark is that we ended the third quarter with a product backlog of over $17 million. This was the sixth consecutive quarter that ended with a material backlog.

Based on our solid nine-month results, and in anticipation of continuing to execute in our fourth quarter, we are in a very good position to deliver within the full year guidance we provided at the beginning of the fiscal year. We are therefore re-affirming and in fact tightening the revenue and EPS guidance we provided nine months ago.

During the quarter we saw growth in total bookings coming in at 20% over the same quarter last year. Total bookings include new business and renewal bookings. Our service provider business remains strong with year-to-date new business bookings up 51% over last year.

Despite the challenging economic environment we saw growth in new business bookings of 9% in both financial services and general enterprise. The government sector is still facing uncertain funding. Even though we are involved in long-term strategic projects the timing of funding is not clear and our visibility continues to be poor. This is reflected in our year-to-date government verticals new business bookings decline of 30%.

Notwithstanding the current weakness in government, particularly the federal portion, we more than made up for it in the service provider sector of our business. We achieved these good results against a backdrop of economic uncertainty, so we are pleased that our vision and strategy continue to strengthen our market leadership.

Our research and development teams remain focused on providing our customers in both enterprise and the service provider segment with a steady stream of new product capabilities and enhancements, many of which we'll be announcing at our next user forum in early April.

With a steady stream of small and focused acquisitions in the last 18 months we have not only enhanced our technology and product portfolio, but we have also increased our R&D resources and skill set, positioning us for continued strong output and accelerating time-to-market with industry-leading new products in the next fiscal year.

At the beginning of November we acquired privately held ONPATH Technologies based in New Jersey. ONPATH is a provider of high-performance, packet flow switching technology that adds to the intelligent switch products that we acquired from Simena a year ago.

ONPATH brings us a newly developed state-of-the-art switch that is based upon a scalable modular chassis-based design and targeted towards high-density networks with ultra low latency requirements. Their technology is used in high-performance network for the aggregation and distribution of network traffic for data, voice, video testing, monitoring, performance management and cyber security deployment.

These switches support more than 500 ports of 10 gigabit Ethernet per chassis along with market-leading densities for 40 gigabits Ethernet and [future] support for 100 gig interfaces. We can now deliver a comprehensive ultra low latency switch portfolio with industry leading performance and port densities that will be easier for customers to integrate and manage. This will give enterprise and service provider organizations the ability to address a diverse range of deployment requirements to include efficiency control and distribution of valuable network traffic flows.

The overall success we are seeing in the market [scene] stems from our strategies of Unified Service Delivery Management which is aimed at consolidating service assurance and performance management capabilities for a multiple IT operations team on a common packet flow platform. Our strategy of one box on the wires combined with continuous enhancement of a software solution is gaining traction across our dual markets.

Our focus on probe consolidation, a single data source supporting both network and application performance management as well as both data wise service assurance makes NetScout easier to do business with and is aligned with our customers' go green initiative.

In summary, looking ahead into the fourth quarter we anticipate maintaining a steady growth trend. Based on our nine-month results we are reaffirming but tightening our full-year guidance range from [EBIT] GAAP revenue to be in the range of $346 million to $350 million and non-GAAP revenue to be between $347 million and $352 million.

On the bottom line we have narrowed GAAP net income per diluted share to be in the range of $0.92 to $0.96 and we have raised non-GAAP net income per share to be between $1.28 and $1.32. We look forward to sharing our full-year accomplishments and results with you next quarter. Michael will now discuss some additional highlights of our performance.

Thank you, Anil. In my comments I will focus on our execution and operational performance this past quarter. As Anil mentioned, the acquisitions made last year are delivering results. In addition, we are extending our leadership in the IT assurance segment in the wireless service provider market, particularly for more investment in capabilities for the cable providers and increased focus on the wireless service provider customers in the EMEA, Europe, Middle East and Africa market.

In the enterprise we have continued our engineering development to expand the nGenius platform to [assist] the needs of application performance management based on our unique ESI technology, and to deliver an expanded packet flow switch portfolio to capture additional growth from the fast-growing monitoring switch market.

Looking at our bookings performance, I would like to highlight our continued strong execution in the service provider sector. As noted, our expansion continues into the cable MSO segment where we are providing solutions that allow these providers to manage user experience in the areas of WiFi hotspots and TV Everywhere, in particular allowing the sector to better compete with wireless service providers and minimize customer churn.

This quarter we won two large deals over $1 million with leading US cable providers and also see growing opportunity in Europe for our solutions. We also saw increased demand in LTE deployments globally, particularly in (inaudible) operators in Asia Pac and EMEA. In EMEA we saw a good uptick in business from established Tier 1 customers resulting from our sales organization realignment. In addition, we have been focusing on increasing post-sale services to drive faster time to value and customer satisfaction for our service provider customers.

We are on track with the integration of voice service assurance product that we acquired from Accanto Systems and the first release based on our common (inaudible) platform is slated for launch in the first half of this calendar year.

In addition to early VoLTE initiatives the demand for solutions combining 2.5G and 3G voice and 4G LTE data continues strong in the wireless service provider segment and NetScout is well positioned to meet this demand with the expanded nGenius service provider portfolio. Based on this new capability and our continued investment in IP assurance we expect that the service provider part of our business will continue sustained significant growth.

On the enterprise side we have many exciting initiatives on the way. We continue our focus on expanding in international markets and are happy to acquire a new customer within Latin America during this quarter. We saw business in Latin America with a large -- (inaudible) larger than $1 million from a financial institution in Brazil. NetScout gives this customer real-time service visibility in (inaudible) proactive service delivery management across its globally distributed cloud network and data center infrastructure.

Another area of expansion within our enterprise business is expansion in the packet flow switch market. The packet float switch product line is highly synergistic with our nGenius monitoring solutions, allowing our existing customers to extend the value of the investment -- their investment in NetScout.

The expanded product line also gives us the capability to participate in a large-scale data center project ranging from enterprise to service provider to cloud applications providing us with the opportunity to expand our customer base.

Finally, and of most interest for our enterprise business, we are continuing the ongoing development of functionality for employment of our nGenius USDM (inaudible) management solutions to address application performance management. Our expanding focus on APM is leveraging our market-leading packet flow platform to provide unique value to the entire IT operations team including the application support team and the Unified Communications team.

We are in close dialogue with our leading NetScout user (inaudible) members and are incorporating their input into our development process. General availability is slated for early in the next fiscal year and we will begin the sales effort during the first quarter. Our solutions will bring unique real-time information to the application support teams about the application (multiple speakers) services actually delivered to the end-users complementing their current toolsets.

Earlier this week we announced that NetScout joined the Open Networking Foundation to help address the expected opportunities and challenges of managing the delivery of services from SDN or software defined networking architecture. The Open Networking Foundation is a nonprofit organization recognized throughout the networking industry for its dedication to improving SDN standards and solutions worldwide.

As a member of the Foundation we will collaborate on approaches to address the new performance management challenges associated with implementing and running SDN-based service delivery environments for both enterprise and service provider customers. NetScout believes SDN will help drive the transformation of modern enterprise service provider and cloud operator data center and service delivery networks and will bring substantial infrastructure efficiencies as well as enable new services.

However, the resulting virtualized network will create an even greater level of interdependency between network traffic, control traffic applications and enabling technology. Consequently assuring service levels and providing a superior user experience require complete visibility and understanding of multiple dynamically changing traffic flows.

Finally, during the quarter we were ranked number 402 -- 402nd on Deloitte's Technology Fast 500, a ranking of 500 fastest growing technology, media, telecommunications, life sciences and clean technology companies in North America. According to Deloitte, NetScout grew 184% from 2007 to 2011 which was the subject years, and we were ranked 44th in the communications networking category. This was our third consecutive year on the Deloitte list. I would now like to turn the call over to Jean for the financial discussion.

Thank you, Michael, and good morning, everyone. We will be starting with the third slide of our presentation which is accompanying our call and is posted on our website. As Anil outlined, our business continued to perform against our goals for the third quarter of fiscal year 2013.

Our third-quarter non-GAAP product revenue grew 15% and our total revenue grew 10%. Our non-GAAP earnings per share increased by 3% over our third-quarter FY'12 earnings per share as this quarter absorbed the operating expenses associated with our recent acquisitions that are in the product development stages.

Our third-quarter non-GAAP total revenue was $92 million which is an increase of 10% from the same quarter in fiscal year 2012. Within non-GAAP total revenue, non-GAAP product revenue was $52.7 million, which is an increase of 15% over the same quarter in fiscal year 2012. Service revenue was $39.3 million on a non-GAAP basis which is a 5% increase from the same quarter in the prior year.

The GAAP total revenue for the same period was $91.6 million, which is an increase of 10% from the same quarter in fiscal year 2012. Within GAAP total revenue GAAP product revenue was $52.7 million which is an increase of 15% over the same quarter prior year. Service revenue was $38.9 million on a GAAP basis, which is a 4% increase from the same quarter in the prior year.

On a non-GAAP basis our earnings per share for the second quarter were $0.36, this is $0.01 higher than the third quarter of fiscal year 2012 and represents a 3% increase. On a GAAP basis our earnings per share were $0.26, this is $0.02 higher than the third quarter of fiscal year 2012 and represents an 8% increase.

Our third-quarter operating margin, net income margin and earnings per share, both on a GAAP and non-GAAP basis, were impacted by this quarter's acquisition of ONPATH Technologies and the second quarter's acquisition of Accanto. Our engineering teams are in the development stages of incorporating and integrating the technologies that we have acquired from these two acquisitions into our existing product suites.

As we have previously discussed, the product development for these technologies is being engineered over the second, third and fourth quarters of this fiscal year with the product offerings anticipated being available beginning in the fourth quarter of this fiscal year and the beginning of our next fiscal year.

Turning to slide 4, the business maintained strong growth profit margins. On a non-GAAP basis our gross profit was $74.2 million representing an 80.7% margin. Our GAAP gross profit for the quarter was $72.4 million and GAAP gross margin was 79.1%.

Non-GAAP income from operations was $24 million. Our non-GAAP operating margin for the quarter was 26.1% which is a 2.5 percentage point decrease from the same quarter of prior year. This decrease is attributable to the integration of our recently acquired technologies, as I discussed earlier.

GAAP income from operations was $17.6 million. GAAP operating margin was 19.2%, which is a 1.7% decline over the same quarter in the previous year. Non-GAAP net income was $15.3 million or $0.36 per diluted, share, the non-GAAP net income margin was 16.7% which is down 1.1 percentage points from a year ago. GAAP net income for the quarter was $11.1 million using earnings per diluted share of $0.26. GAAP net income margin was 12.2% which is an increase of 0.2 percentage points from a year ago.

The major differences between our non-GAAP and GAAP income from operations for the quarter is the exclusion of stock-based compensation for $2.5 million and about $3.6 million of costs associated with our acquisitions which includes amortization of intangibles for $1.8 million; business development expenses totaling $500,000; $1 million for deal-related compensation; and $250,000 for inventory fair value adjustments. These are detailed in our reconciliation of our non-GAAP to GAAP results presented in our press release.

The quarter's provision for income taxes is recorded based upon a full-year tax rate of 36.8% on a GAAP basis. And this does not include any impact of the recently signed fiscal cliff legislation. Our GAAP tax rate for the quarter is 36.2%.

Consistent with past practice we have used a statutory tax rate of 38% to tax effect the non-GAAP adjustments. The adjustments reconciling our non-GAAP results to our GAAP results are summarized in the reconciliation table included with our press release.

Turning to slide 5, which shows our total bookings and new business bookings composition, total bookings in Q3 were $99.7 million, an increase of $16.9 million or 20% year over year. Within total bookings our new business bookings were $66.3 million, an increase of $8.9 million or 16% over the prior year's third quarter. Service contract renewals in the quarter were $33.4 million, an increase of $8 million or 31% year over year.

Product backlog at the end of the quarter was $17.3 million. The components of our new business bookings for the third quarter of fiscal year 2013 were as follows -- service providers 36%; financial enterprise 25%; government enterprise 7%; general enterprise 32%. This compares with the prior year quarter's new business bookings components as follows -- service provider 33%; financial 24%; government 11%; general enterprise 32%.

Slide 6 is a summary of our deals for this quarter. For large deals within the quarter 197 customers gave us orders of over $100,000 in comparison to 166 customers from last year. We received 17 orders over $1 million of which nine came from service providers, three from financial services, five from general enterprise.

This compares to 10 orders over $1 million that we received last year in the third quarter. Last year's orders that were greater than $1 million included five from service provider; one from financial services; two from government; and two from general enterprise.

For year-to-date fiscal 2013, slide 7 shows our results. For the first three quarters of fiscal year 2013 non-GAAP revenue was $253.1 million, which is an increase of 15% from fiscal year 2012. GAAP revenue for the three quarters of fiscal year 2013 was $252.5 million, which is also an increase of 15% for fiscal year 2012.

Non-GAAP and GAAP product revenue was $139.1 million for the first three quarters of fiscal year 2013, an increase of 22% over prior year non-GAAP and GAAP product revenue.

Non-GAAP service revenue was $114 million and GAAP service revenue was $113.4 million for the first three quarters of fiscal year 2013, this is an increase of 8% over prior year for non-GAAP and 7% for GAAP service revenue.

On a non-GAAP basis our year-to-date gross profit was $204.7 million representing an 80.9% margin. This margin was 50 basis points higher than the prior year. Our GAAP year-to-date gross profit was $199.5 million and GAAP gross margin was 79% which is 30 basis points higher than the prior year.

Non-GAAP year-to-date income from operations was $61 million. Our year-to-date non-GAAP operating margin was 24.1% which is 1.8 percentage points higher than prior year. GAAP year-to-date income from operations was $42.7 million. GAAP operating margin was 16.9% or 1.7 percentage points higher than the previous year.

On a non-GAAP basis our year-to-date earnings per share for fiscal year 2013 are $0.90. This is $0.19 higher than year-to-date for fiscal year 2012 and represents a 27% increase. On a GAAP basis our year-to-date earnings per share were $0.62.

Turning to slide 8, which shows our total bookings and new business bookings growth for the first three quarters of fiscal year 2013, total bookings year-to-date for fiscal year 2013 was $253.7 million, up $29.8 million or 13% year over year. Within total bookings new business bookings were $187.8 million, up $24.8 million or 15% over the prior year. Renewal bookings were $65.9 million which is an increase of $5 million or 8%.

In spite of the economic challenges facing our customers across the globe, in the first three quarters of fiscal year 2013 all of our business verticals experienced growth in new business bookings over the prior year except for government. We believe the decline in government new business bookings is due to the budget uncertainty around long-term government projects as Anil discussed earlier.

Our new business bookings for service provider sector grew 51% on a year-over-year basis as we continue to win new customers and LTE deployments across the globe. Our new business bookings for the financial enterprise sector have grown 9% on a year-over-year basis. We've experienced a third quarter of domestic financial services institutions purchasing for their service offering enhancements as well as data center changes.

Our general enterprise sector grew 9% on a year-over-year basis. The growth in this vertical has come from diversified sectors including utilities, manufacturing and communications industries. The new business bookings for government verticals decreased 30% over year largely due to the federal government deferring spending on long-term strategic initiatives.

Our federal government new business bookings decreased 32% while the rest of the government business, which includes foreign governmental agencies and state governmental agencies, decreased 26%.

Slide 9 shows our new business bookings composition by vertical. The components of our new business bookings for fiscal year 2013 were as follows -- service provider 39%; financial enterprise 26%; government enterprise 10%; general enterprise 25%. This compares with the prior year new business booking components as follows -- service provider 30%; financial enterprise 28%; government enterprise 16%; general enterprise 26%.

Turning to slide 10, this is a depiction of our year-to-date revenue by geography. For the first three quarters of the fiscal year revenue from international sales was 25% of total revenue as compared with 26% of total revenue for fiscal year 2012. Within our international sales Europe delivered 12% which is 1 percentage point higher than last year. Our Asia sales were 5% for the first three quarters as compared to 6% last year. And the remaining international business was 8% compared to 9% last year.

Our European revenue of $31.4 million has grown 30% over the FY'12 year-to-date period. Our Asian markets have declined by about $700,000 over the prior year results. While we continue to see a difficult climate for our European and Asian financial services institutions, we have been able to expand our footprint in are European service provider market.

Slide 11 includes highlights from our balance sheet. 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 $136.7 million. This represents a decrease of $76.8 million from the prior year's ending balance for cash and short- and long-term marketable securities of $213.5 million.

Our year-to-date free cash flow generation of $58.8 million was $22.8 million higher compared to the first three quarters of fiscal year 2012. In the quarter we repurchased 250,000 shares for $6.1 million. On a year-to-date basis we have repurchased 750,000 shares for $17 million.

Accounts receivable net of allowances was $61.9 million, down from $69.8 million at the end of fiscal year 2012. Days sales outstanding were 61 days for the quarter; this is up from 54 days for the third quarter of last year.

Inventories were $7.4 million; this is a $600,000 decrease from the fourth quarter of fiscal 2012. Inventory turns have increased to 4.3 times in the quarter from 3.0 times for Q3 fiscal 2012.

During this quarter we paid the outstanding balance of $62 million on our revolving debt facility. Since this is a revolver the $250 million facility is available to us should we need it over the remaining full-year term of the agreement.

Our liquidity at the end of the third quarter was approximately $387 million. Additionally, our total deferred revenue was $113 million which is an increase of $1 million from fiscal 2012 year end.

Turning to our guidance for fiscal year 2013, slide 12 illustrates our growth for revenue and earnings per share. For fiscal year 2013 we are narrowing the non-GAAP revenue guidance to $347 million to $352 million yielding a revenue growth rate of 12% to 14%. We are raising guidance for our non-GAAP net income per share to be in the range of $1.28 to $1.32 yielding EPS growth of 16% to 20%.

For fiscal year 2013 we are narrowing our GAAP revenue guidance to $346 million to $351 million and adjusting our GAAP net income per diluted share to be in the range of $0.92 to $0.96.

The EPS guidance reflects tax legislation which reinstates the research and development tax credit on a federal basis. This reinstatement is retroactive for the calendar year 2012 and effective for the calendar year of 2013. Accordingly, we will experience an R&D tax credit in our fiscal year 2013 results for five quarters and we'll experience in fiscal year 2014 results an R&D tax credit for three quarters. The skewing of the quarters correlates the calendar years of 2012 and 2013 with our fiscal year.

For fiscal year 2013 the non-GAAP net income per diluted share expectation excludes the purchase accounting adjustment to fair value of approximately $1.2 million for deferred revenue; forecasted share-based compensation expenses of approximately $9.7 million; estimated amortization of acquired intangible assets of approximately $7.5 million; inventory fair value adjustment of approximately $500,000; compensation for post combination services of approximately $2.5 million; restructuring charges of approximately $1.1 million; business development charges of approximately $1.4 million and the related impact of these adjustments on the provision for income taxes of $8.6 million.

That concludes our financial discussion this morning. Thank you for joining us and we will look forward to taking your questions. Denise, we will now take questions from the attendees.

(Operator Instructions). Mark Kelleher, Dougherty & Company.

I was just wondering, the 4G LTE rollout, I know we talk about this each quarter, but could you give us an update on kind of where the sector is and where the CapEx spending is in the cycle? Is that something that is surging now and going to peter off? How do you see your revenue into that sector playing out over the next couple years?

Well, first of all, the sector includes -- the way we report it includes a lot more than 4G and LTE, because there is still -- as you know, we bought this company, Accanto, and we have not been playing in the voice space until now seriously. So we expect some revenue coming from there.

So, we think the sector growth will be -- may not be (inaudible) as big as this (inaudible) this quarter, but it is going to be very decent and above our enterprise growth next year.

In terms of LTE, I think we are sort of in the middle of the wave. And so, I think we expect this trend to continue for a while. And maybe trend downward later in next year.

Shifting from North America to the international market, that is the general trend.

And also we have been most -- a lot of our LTE deals have been coming for Tier 1 providers. But Tier 2 is also an opportunity moving forward. So overall, the trend will be -- we see good growth like this year in the overall sector, maybe the LTE component will be slightly lower than this year.

Okay and a quick balance sheet question. The receivables seemed to jump up a little bit from September to December. Was there some linearity or some effect of acquisitions driving that?

There would be minimal effect of acquisitions; the vast majority of it is the linearity and the skewing of when the orders came in, especially when we had large renewal bookings this quarter, as you noticed, and when they come in in the last few days the receivable isn't collected at that point.

Okay, great. Thanks.

Eric Martinuzzi, Lake Street Capital.

First a comment. I think there is a disagreement between your slide 9 script and the PDF out there, a reversal between the fiscal years on the slide. So you would want to correct that as quickly as possible I think.

Okay, thank you, Eric.

Yes. And then, you talked about the acquisitions and how quickly they contribute, I realize it is early days in Q4, but between Accanto and ONPATH, which do you see between those two is contributing and are you seeing any evidence in your pipeline?

Well, we are seeing some evidence in the pipeline for ONPATH, but that we expect that this year is virtually zero from both of them, it is not a big impact we are going to see. ONPATH is still -- we're just about to announce formally the product. And (inaudible) the pipeline is growing. On the Accanto side we will be finishing the full integration of the product in the next quarter time frame.

So yes, pipeline is (technical difficulty). As you know, the pipeline was (inaudible) switch, but already building with the previous acquisition to ONPATH. And so, we don't separate the pipeline for packet flow switching (technical difficulty) acquisition and second. But overall there is a lot of interest and there are a lot of evaluations going on in terms of customer trying to do a proof of concept.

Okay. And then on the federal side, obviously times are tough there. Just curious if there is any relief in sight, again, looking into the pipeline. And if not are there moves that need to be made on the cost structure side?

I think we see that -- we don't see any (technical difficulty) need to make any changes right now in the cost structure side. The pipeline has not changed; pipeline has really not changed because our sales team still thinks that all those deals will come through. And so, what we have to watch out is let's see what happens over the next three, four months. Certainly we are not planning to make any changes this fiscal year.

Okay, and then just my own congrats on a good strong execution there in December.

Thank you.

Thanks, Eric.

Thank you.

And also congratulations on your -- good luck with your new company.

Thanks, Anil.

Alex Kurtz, Sterne, Agee.

Congrats on the results again. Jean, if we could just go back to the DSO question from earlier. Again, it looked like it doubled sequentially here and if I look back at last year DSOs were down from September to December. So could you just give us a little bit more color about why this wasn't abnormal?

Sure. Well, when you compare it to last quarter, if you recollect we had some large deals from a service provider that came in earlier in the quarter, so we would have had the opportunity to collect those receivables during the same quarter. And I think, as I mentioned last quarter, that was a major impact as to why the DSOs were so low. And they were probably lower than the trend.

In this quarter we don't have -- we really don't have any collection issues or any issues like that. We -- it just happens when you have larger orders come in towards the end of the quarter you don't have the same time period the time to collect them. And this is especially true in any kind of a quarter where you get large renewal deals.

And this quarter, as you saw, we were -- our renewals were $33 million -- $31 million and last quarter they were about $16.5 million. So we don't see an abnormal -- we don't see any trends in there that we are worried about with DSO, it is just more of a function of the timing of the orders coming into the quarter and then when we have the ability to actually collect the cash in the next quarter.

That makes sense. And my last question here is if I look at your guidance, it implies product growth sort of single-digit for the March quarter. I know you are up against a tough comp from last year; I think you grew like 21% last year in March. So is that just an element of conservatism? Is it really just because you are up against a tough comp or do you think there is potential to do more than that?

I think, Alex, as we spoke at our IR meeting in November, I think with the lumpiness of the deals and the way our business grows, I think we should not be looking at our comps or numbers on a quarterly basis. We have programs in place, for example, which allowed us to pull in some business from Q4 into Q3 and probably did it earlier in the first quarter also. That is why we give yearly guidance.

So I think our yearly guidance still shows strong growth and we feel very good that we are maintaining the guidance with one full year and we'll probably be delivering towards the high-end of the guidance.

So, I am not looking at the Q4 number growth just by itself. I think we have different ways in different years to meeting the yearly guidance and individual quarters will be up and down. We do have to do these earning calls every quarter, but really we are looking at on a yearly basis what we are going to do.

Thanks, Anil.

Aaron Schwartz, Jefferies.

In addition to the commentary on the service provider vertical, it looks like fin services for the quarter here has sort of a rebound quarter. Was that just maybe a little bit of a function of some Q4, some December quarter budget flush or do you have any sort of better visibility into trends in fin services right now?

I think it is two things. One, is we have been discussing over the last few quarters the domestic financial service institutions have been buying at a good clip. So we had, as we talked before, one of our customers, a large financial institution, who was enhancing their service offering, was doing a website rollout and bought then.

We've also through our new product enhancement, the NVVM and certain things have gotten some financial institutions in the last few quarters that have been making low-single-digit $1 million deals to kind of a new customer entree. And then we have had a customer who is a large financial institution who had not been buying for the last few fiscal years who has started to come back and work on their data centers, whether they are expanding them or whether they are upgrading them, and they have been purchasing also.

And then as Michael had mentioned to you, we were very happy this quarter that in Latin America some of our international efforts were fruitful where we did get a new customer, a financial institution in Brazil. So at this point, it is three quarters of domestic-based spending that is -- for the most part that is causing the 9% increase in financial services.

Okay, and then the commentary on some of the new products there, I mean, does that give you any sort of different view into the pipeline end of that vertical going forward or is it still just somewhat of a lumpy outlook into fin services?

Probably in dealing with me you know I tend to be more conservative, that is why -- this is the first time that we have mentioned it's the third quarter of domestic growth. I think we would say we see the domestic market purchasing. It could be a degree of budget flush, but we continue to leverage our relationships and we have long-term excellent relationships there. In the international markets we have seen a little bit of business but not a lot. I wouldn't call it any kind of a trend that is starting over there.

Okay, I just had a question on the OpEx side -- actually sort of two questions. One, the sales expenses jumped up a little bit here, you would expect that given the bookings growth. But the bookings growth has also seen -- or based on very strong renewals. I guess is the increase in comp here tied to the renewals as well or is that variable comp tied more to just the product side of the new bookings?

When you look at our first three quarters of FY'13, they went -- it was like $25.5 million for sales in Q1 and then this quarter is around the same, it's about $1 million, it does reflect higher incentive compensation.

It really was that, as we discussed last quarter, there were some significant purchases and the incentive compensation structure around those purchases and service provider were such that they hadn't attained their quota yet and they had lower sales incentive compensation.

So it was more that Q2 was an abnormality than any kind of change in Q1 over Q3. And we do have incrementally a few -- some more salespeople from the ONPATH technology, but it doesn't move the needle that dramatically.

Okay. And last question for me if I could. I hate to keep hitting on the receivables here, but it also looks like the deferred has seen just very modest shifts, more to the long-term side. Are you seeing more multi-year renewals here and do you collect the cash up front on the multi-year deal side as well? And then, do you have any update on the collections since the quarter has closed?

Sure. One, you are definitely correct. We have extreme customer loyalty and our renewal bookings continue to show that in the fact that many of our long-term large customers continue to renew on multi-years, which shows the significance and the importance of how we are to their infrastructure.

When we collect those, they are collected up front for the most part, so they will pay up front and then we just do the deferred revenue, the revenue recognition over the rest of the period. And honestly I'm not worried about anything in the receivables. There is nothing that is -- there is nothing of interest in there. We have -- most of the Fortune 500 is what is in our receivables. So we really don't have many credit risk or credit worthiness issues.

Okay, terrific. Thanks for taking the questions.

Matt Robison, Wunderlich Securities.

What should we expect your tax rate to be on this catch up for the R&D credits this quarter?

So for the next quarter -- so for the annual rate we are looking at basically the same rate year over year. So last year we would probably say it's going to be in the 35 -- 35.75% to 36%. So in Q4 the tax rate will probably dip down to about 32.5% as we take the five quarters of the R&D credit.

Okay, what was the operating cash flow, CapEx and depreciation in the fourth quarter -- I mean in the third quarter?

So CapEx was $8 million for the year; it would have been about $3 million for the quarter. And let me get the depreciation for you. Depreciation for the quarter was $2.8 million, amortization was $1.8 million.

That was for the quarter?

That was for the quarter.

Okay, I can back into the operating cash flow I guess since you gave free cash flow.

Yes, free cash flow was -- we had said in the script it was about $66.8 million from cash from operations less the $8 million. And you want free cash flow for the quarter you mean?

Well, I can get there, so that's okay.

Okay.

How much did you spend on the ONPATH acquisition?

We usually don't disclose that amount. It will be in the Q as we have discussed before. And it would have been a significant reduction of cash this quarter.

Help us work with that since you are putting it in the Q anyway.

So for ONPATH we paid around -- in cash about $35 million to $40 million. And then we did a debt repay down of $62 million.

Okay. On the Voice over LTE, are we seeing any meaningful orientation towards HD voice or do you see it more as this general IP convergence as far as what's getting the carriers going? And if you are seeing HD voice what does that mean for you in terms of things you can bring to the customer from a value proposition?

Yes, we don't really see HD voice yet. I think it is more just the IP convergence is at play.

Okay, that's all I have for now. Thanks.

Chad Bennett, Craig-Hallum Capital.

Probably a couple for Jean. Jean, can you give me the service provider geographic breakdown from a bookings standpoint?

Sure. For the full year we had -- you want the composition?

Yes. Yes, so how much was US versus, you know, however many segments you do for international?

Okay. So --.

And for the quarter too if you have it.

We talked about before predominately it is US-based, the split is still about the same, it's 75% for the first three quarters of fiscal year, still 75% or so US-based with the rest coming from EMEA and APAC.

Would that be kind of comparable for the December quarter also -- as far as you can tell?

It probably would be shifting slightly more towards international only, as we've talked about, we are getting expansion and traction there. I doubt it would be -- at this point I doubt it would significantly move any of the dials.

Okay, thanks. And then going back to a prior question on kind of how you are feeling about the financial vertical and kind of consistent traction there or an uptick in spending. I guess a question on that is in the financial vertical is the growth you experienced this quarter and for the last few quarters quite frankly, is it mainly existing customers kind of catching up on spending or kind of refreshing data centers and infrastructure or is it -- are you seeing kind of new customer additions in that vertical?

I think maybe Jean has something, but we talked -- certainly talked about a big deal international which was a new customer. But US I mentioned are mostly existing customers. It's not a mass refresh of the data center, but we are really getting most of the business from existing customers (multiple speakers).

There is also increasing opportunity in Asia and China; we see some promise there (multiple speakers).

So the financial institutions, to go back to your question, we actually see all three of those. So we do see one long-term customer who has been doing some data center refreshes in the last two quarters. We have seen some financial institutions that may have been long-term customers but that had been dormant that are interested in some of our new technologies.

We also have the domestic financial institutions that have been long-term customers that continue to enhance their service offerings. And then as we have talked about, we saw some -- we saw a new deal in Latin America. But again, the European and the Asia pack banks have yet to come back. That would probably be the way we'd summarize the financial sector.

Okay. And the ONPATH and Simena products -- packet switch products, can you talk about at least kind of directionally what we should expect from a margin -- gross margin profile on those products relative to the corporate average for product gross margin?

I think it's going to be slightly lower, it has (inaudible) so it will be slightly lower than the current margins. But we don't see any big change in our overall (inaudible) margins for next year despite that mix. Because still the non-PFS, non-Simena and ONPATH will still be a fairly small portion of the total revenue. Okay?

Scott Zeller, Needham & Company.

I wanted to ask about the prepared remarks and your comments on the cable MSO group. I don't recall that being a significant contributor in the past. Can you tell us when you think about telco and service provider versus MSO how do you look at the balance of contribution right now and how is it trending?

Well, cable MSO is still a small percentage of the service provider -- overall service provider revenue picture. Our wireless service providers and Tier 1s in particular are driving that still. But there is a very nice trend of growth in the cable MSO segment as we are able to apply our solutions developed for the wireless service providers to this segment as well. Essentially very similar fashions, solving similar problems. And we see this opportunity as continuing to grow, but remaining a small portion for the foreseeable future.

Okay, and I may have missed it earlier, but I am curious about any changes in the field now that Opnet has had its change? Can you talk about how maybe the intensity of competition in the field and how that has changed?

Yes, surprisingly we are not seeing any change right now. Maybe they are still trying to get reorganized and closing the acquisition and all those. So we have not seen any change in the market, absolutely zero change surprisingly. We expected more. But overall we see Riverbed and Opnet acquisition is more positive for us both in terms of creating awareness, but I think we must be in a much better position to win.

Yes. And I believe, Jean, earlier you had mentioned the year-to-date contribution from international, but can you tell us what the quarter itself looked like for international versus domestic?

Sure. That is revenue -- probably not. I don't think I have that at my fingertips. I can give you a call back and we can talk about it.

Well, in that case maybe you could just say if the split has been consistent over the past few quarters?

When you do it the split is consistent year over year over year. What we did see this quarter, which slightly moved the European mix higher, was that the reorganization that we did in the summer and the focus that we have on service provider in that market added -- expanded our footprint so that the European portion went up about 30% year over year. But consistently it has ranged from 24% to 26% as a portion of our revenue.

Thank you, that's it.

Sanjit Singh, Wedbush.

I wanted to see if we can get an update on your moves into the [APM] market, what new products we could see along those lines. And then digging into the general enterprise market, I think we understand what is going on in federal. But what are you seeing in terms of sales cycles, how cautious is the spending environment, particularly in the general enterprise?

I think general enterprise is cautious, but it's I think still reasonable and, as our number shows, we expect the environment to not change that much. I think in terms of a market opportunity we were getting -- even though we played all the time in both APM and NPM market, most of the revenue and relationship was attached to the NPM market. And the APM market is significantly bigger.

So we have been working on some modifications to our ASI technology to create an enhanced product in the next quarter for the APM market. And I think that will increase our access to more budgets in existing account because of the focus on APM. So we expect that to be a big contributor in terms of maintaining or exceeding the percentage of growth in the enterprise segment next year.

Great. And on R&D, I was a little bit surprised to see it generally flat quarter over quarter given the two acquisitions, Accanto and ONPATH. Does that imply that you guys took more sales and marketing heads versus development heads? Why was R&D flat quarter over quarter given the acquisition?

We do take mostly R&D headcount when we do these acquisitions, especially for Accanto and ONPATH. R&D is flat over the quarter probably because we have had some significant meetings and stuff that occurred in Q2 that we didn't experience in Q3.

Okay, thank you very much.

Kevin Liu, B. Riley Caris.

Regarding the SDN opportunity, I know it is kind of early days there, but just wanted to know if you could talk a little bit about what sort of enhancements if any were kind of required of the platform in order to pursue that market.

Well, there are two things we had to do. And one is -- and they all fall in activities in a new opportunity. One of the things which we cannot not do in a probe type solution we are sniffing the wire and doing various things is to what is happening to the configuration of devices. And because those are done with some proprietary matter.

What SDN does is brings that configuration management to the mainstream. So now the open floor SDN is itself an APM like application and we can -- people will need more management and ways to manage the configuration across the infrastructure. So that is an opportunity for us with SDN when the time comes.

The second thing is for the PFS market we will need to have our own device managed through SDN and an open flow. So that will require some extra work. It is not going to drive the business but it is going to require extra work.

So in general then, supporting other people's configuration through monitoring architecture of APM and maintaining our -- being able to manage our own devices just like a Cisco router would be managed by SDN products are two things we will need to do next year.

Got it, and just one last one. On the packet flow switches, I know you have talked about near-term maybe it is not a big revenue contributor, but certainly with the Simena progress you guys have shown, as well as the recent acquisition [of amount] you paid for that.

I would assume your thoughts are that that turns into a fairly sizable market opportunity for you? Any sense for how many points of growth that could add over time on the product side and is that contemplated within your prior outlook (multiple speakers)?

When we give the guidance for next year you will see that number embedded in there. We don't separate it out, are not planning to separate it out. So your guidance when we give I think will be a reflection of that. And also I want to correct that we are not saying that PFS business will be small, we are saying it is not going to be big enough to make a big change in our gross margin model.

Great, thank you.

So we think that number will be significantly bigger than this year.

(Operator Instructions). Gary Spivak, ABR Investments.

I echo congratulations on the quarter. I want to dig into the backlog a little bit. I know it is not something you guide for, but do you have a target -- is there a level where backlog is just too much or is that a case where more -- the bigger the better? And then also if you could discuss the split in the backlog between service provider and enterprise.

The backlog, as we have talked about in the past, it is pretty varied; it is not really consolidated in any industry or anything like that. And a small function of -- as we get towards the end of the quarter, when customers place orders how much can we actually physically get out the door.

So to that end the backlog definitely adds a level of comfort, anything above $10 million is what we would be reporting as material. We don't really target what we want to keep in backlog and it doesn't get too -- if backlog does get too large, as you talked about, it does become operationally sometimes difficult to start shipping things out in the beginning and still attaining -- and still getting all of your other customer orders.

So there is not really a strategy per se around backlog other than it is a very nice -- it's a very nice amount to have on our financials.

Right, I'm sure it is. And I guess the other question, Jean, is again if we look at the receivables again, let me ask the question a little bit differently. Given the profile of the renewals in the December quarter can we expect the phenomenon not to be quite as strong in March which could potentially result in better linearity in the March quarter?

Well, Q3 as it is the calendar year close of many of our customers, the renewal, because it is of a contract nature, tends to be heavier in -- it tends to be heavier towards Q3. With that said, I probably would see maybe the same levels to slightly lower in Q4 and it could affect the DSOs so that they are comparable to what they were at last year.

But we are not -- but I just want to stress, there is not -- that we don't have an issue with our receivables and we are not doing anything with collections. Our cash flow, as you can see, and our free cash generation is very good this year. So we are comfortable with the receivables.

Right. I guess my question is just about anticipated linearity versus a little bit more back-end loaded this quarter because of the renewals?

The DSO, yes. It was probably a little more back-end loaded because of the renewals at the end of the year. And again -- at the end of the calendar year. And again, Q2 was artificially low due to the fact that we got some very large orders early in the quarter last quarter and we were able to collect them by the end of the quarter.

Got you, thank you.

Mark Jordan, Noble Financial.

I would like to talk about the compensation after the post combination services. Should that decline precipitously in the fourth quarter or how is that going to go moving forward?

That probably will be about the same amount in the fourth quarter, flat. That represents earn outs and other things on some past acquisitions. So we would just see until that burns off or earns comparable periods over the next few quarters.

Secondly, relative to the -- the higher R&D relative to the integration of some of the acquired products in your product line, as those new products become integrated and become generally available should you see efficiencies generated in the R&D expense as you move into the new year?

So what we will see is leverage because the amount of cost that you see embedded in the R&D structure right now is in development of products that haven't shipped yet. So the leverage on that line should improve.

For efficiencies, generally we have multiple centers of excellence that are worldwide that allow excellent product development and coordination. So at this point, at least through FY'14, we are really not looking for any kind of efficiencies from our R&D cost expenses.

Thank you.

There are no further questions queued up at this time. I turn the call back over to presenters.

Okay, thank you, everyone. We will see you again at the end of our fiscal year in three months.

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