Netscout Systems Inc (NTCT) 2014 Q1 法說會逐字稿

Thank you for standing by. Welcome to NetScout first quarter of fiscal year 2014 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 President and CEO, Mr. Anil Singhal. He is accompanied by NetScout Chief Operating Officer, Mr. Michael Szabados, and NetScout Chief Financial Officer, Ms. Jean Bua. At this time, I will turn the call over to Ms. Cathy Taylor, NetScout Director of Investor Relations, to provide the opening remarks. Ms. Taylor please proceed.

Thank you and good morning everyone. Welcome to NetScout's fiscal 2014 first quarter conference call for the period ended June 30. Before we begin let me remind you that during the course of this conference call we will be providing you with a discussion of the factors that we currently anticipate may influence our results going forward. 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 2014, 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, 2013 on file with the Securities and Exchange Commission.

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 slide presentation, you can find it by going to our website at www.netscout.com /investors. And then clicking on today's webcast. While the slide presentation includes both GAAP and non-GAAP results, unless otherwise stated financial information discussed on today's conference call will be on a non-GAAP basis only. Non-GAAP items are described and reconciled to GAAP results in today's press release. I would also like to point out that growth rate discussions are based on a year-over-year basis almost otherwise noted. This concludes the introductory remarks. I would now like to turn the call over to Mr. Anil Singhal, our Chief Executive Officer.

Thank you Cathy. We are pleased with the results of the first quarter of our new fiscal year. Non-GAAP revenue for the quarter was $81.9 million, which is up 7% over the same quarter a year ago despite continued weakness in the government sector of our business. Non-GAAP earnings per share were $0.21, up 11% over last year. Our non-GAAP operating margin was 17%, flat compared to last year at this quarter.

Starting with the current fiscal year we have decided to make some changes to the reporting in our continuing efforts to report and convey our Company's business results to our shareholders in a clear and transparent manner. First we will be focusing the bulk of our discussion on non-GAAP revenue and removing discussion on new business bookings, renewal bookings and total bookings. Non-GAAP revenue represents the actual customer delivered services and solutions that we provided for the reporting period. Secondly, we will discuss our revenue achievement based in three sectors, service provider, general enterprise, and government. We have selected these three sectors based on our operating marketing and buying characteristics as it pertains to our product and customer focus.

At the aggregate level we will focus our discussion on product revenue and total revenue. We will discuss total revenue composition by sector, revenue growth by sector, and our revenue composition by geography. We will discuss these sectors on a year-to-date basis rather than quarterly since there can be anomalies in any given quarter which makes comparison more difficult. Lastly, we will continue to believe -- we continue to believe that our performance is more easily measured over the longer time period and we will continue to provide annual guidance. We will update our annual guidance at the end of any reporting quarter if needed. Gene will discuss these measurements later in our call.

Continuing with our business results within our three sectors, service provider continued to deliver high growth rates that are consistent with our expectations. In this arena we have continued to win deals with our 3G and LTE data monitoring capabilities and are experiencing a steady increase in interest in our early voice over IP service assurance solutions. General enterprise, in which we saw -- which are now including financial services, grew at a respectable growth rate. Our investments in auxiliary products such as our packet flow switching technology continue to do well in this area. Sales of our packet flow switching products have grown since a year ago and are shifting to a balanced mix of modular and based deals, leveraging both our Simena and ONPATH acquisitions. Our initial growth has been fueled primarily by enterprise performance management related deals and our plan is to increase our GAAP share of the equally sizable enterprise security and service provider opportunities. Focus development effort is ongoing through our leadership software features and hybrid capabilities, including the release of a super high density chassis and 100 gigabyte capability in the near future.

The government sector is still in the midst of sequestration and cost cutting issues. Our overall growth was impacted by the year-over-year continued decline in our government business. Despite the funding challenges that have permeated the sector, our solutions have continued to be highly relevant to the needs of a key government agencies. This is corroborated by the solid ongoing renewal business indicating high loyalty levels fro our government installed base as well as good attendance at our recent mini user group meeting in DC. We believe that the federal government will continue to be an important part of our business and for now, we are maintaining our level of investment in government sectors initiatives and resource level.

As we have discussed in the past, we launched our next-generation product targeted at service assurance triage and conversion of NPM and APM called nGeniusONE. nGeniusONE is the result of our leadership and understanding of technology trends within the industry and our unique -- and it's based on our unique and patent pending ASI technology. nGeniusONE represents the first integrative product platform in the industry to address service delivery issues from a network-based and application management perspective. nGeniusONE represents a truly new platform using a very different approach, technology and go to market strategy. We believe our core data source technology, ASI, provides a unique advantage in speed and scale of collecting and exporting relevant data sets to big data analytics platforms. We have been successful in providing business intelligence for our large enterprise and service provider customers and will continue to make this value-added complement software product and service available to our customer base. I'll now turn the call over to Michael who will talk about the nGeniusONE rollout as well as some exciting news on our continued market leadership.

Thank you, Anil. As Anil just discussed, earlier this quarter we launched our flagship nGeniusONE product, implementing our network and applications performance management platform. At the previews to our annual user forum meeting earlier, we extensively piloted the product to enterprise customers and released it for controlled availability in June and we will release it for general availability later this quarter. Initial reaction among early customers has been very enthusiastic and has validated our expectations that users would find it both easier to use and more powerful than the previous generation nGenius product set, or any traditional solutions available in the market today. The new product combines innovations in our core metadata technology, Novell, simple work flows and a state-of-the-art interactive graphical user interface. nGeniusONE is fully backwards compatible with customers' existing NetScout hardware currently in use preserving and extending our customers' existing investment in NetScout.

The product supports diverse data, voice and video environment, including web-based applications such as Oracle and Microsoft, remote desktop applications such as Citrix, public and private cloud environments, unified communication services such as voice over IP and specialized environments such as financial trading. In addition to the tasks our users have already been performing, nGeniusONE enables current and new users to rapidly diagnose complex application and service performance management problems unaddressed by conventional APM tools, such as monitoring and troubleshooting complex and highly interdependent server forms. For example, one of our early users has instrumented their large scale global e-commerce website with streams and nGeniusONE for performance management and rapid troubleshooting of their entire business, down to the level of individual transactions if necessary, in a few high-powered views within our advanced graphical user interface. With the simpler user interface and powerful analytics our goal is to reduce the training and required skill levels to successfully operate the product and thus further reduce the total cost of ownership. With this new platform and its upcoming subsequent releases we expect to increase the value delivered to existing users as well as capture new IT operations users, both in existing and in new accounts.

We also -- we are also extremely pleased and proud to report that we have again achieved the number one market leadership position within our industry. IDC published their 2012 worldwide network management software and appliance market report and NetScout ranked number one with 13.3% market share against all key players, including IBM, HP, and CA. NetScout held the number one position in this IDC report in five of the past six years. Our market share position for 2012 is a strong indicator of our underlying vision and strategy and shows how our products meet needs -- the needs of IT organizations.

In the report IDC also noted growth rates for the industry. NetScout again achieved its leadership position by outperforming the industry substantially in multiple dimensions and growing much faster than the entire segment. This win is only the latest in a long line of awards and recognitions we've won in the past year, including Company awards such as the inclusion in -- Fast 500, Forbes Best Small Companies, and Software 500 awards. And industry awards such as Best of 4G from 4G World, BMC Internet Telephony Product of the Year, and Network Computing, Testing and Monitoring Product of the Year, just to name a few. We believe that the introduction of nGeniusONE last month and the rollout of the product to our existing customers and the broader market will help to continue and strengthen our market leadership in the coming years. I will now turn the call over to Jean for the detailed financial result discussion.

Thank you Michael, and good morning everyone. As Anil mentioned earlier, we will be discussing our results this quarter and in the future with a focus on revenue. This will supplant our previous focus on new business bookings, renewal bookings and total bookings. We will discuss product revenue and total revenue in the perspective of composition and growth. We will continue reporting total revenue by geography. We will discuss revenue composition, revenue growth and revenue by geography on a year-to-date basis only. However given that this is our first fiscal quarter, the results will only represent the quarter at this time. Additionally, we have chosen to report on sectors as service provider, general enterprise, and government.

Since we've entered the service provider market in the 2007 timeframe, our service provider business has grown to almost 40% of our business. The service providers have conceptually similar networks as our enterprise customers but have markedly different services that they provide to their end-users. We will continue to report on the sector separately over the next few years as the carriers migrate to IP-based networks. The remaining 60% of our business represents the original customer base and forms the traditional commercial businesses. We have decided to report separately on government since this sector is differentiated from enterprise by the nature of its services being more in line with security and defense. Over the coming years, as we continue to evolve our product solutions we will further develop our cyber security offering of which we expect the sector to be a major consumer. For historical comparison purposes related to revenue we have provided a slide on our webcast.

Slide 13 in this webcast provides the product revenue and total revenue component by the three sectors for each quarter of our last fiscal year 2013. Additionally, as Cathy noted earlier, my remarks this morning will be based on our non-GAAP results. Our accompanying slide presentation has the comparable GAAP results.

To begin our financial discussion we will be starting with the third slide of our presentation which is accompanying our call and is posted on our website. Our first quarter non-GAAP total revenue was $81.9 million, which is an increase of 7% from the same quarter in fiscal year '13. Within non-GAAP total revenue non-GAAP product revenue was $43 million, which is an increase of 7% over the same quarter in fiscal year '13. Service revenue was $38.9 million on a non-GAAP basis, which is an 8% increase from the same quarter in the prior-year. Our earnings per share for the first quarter were $0.21. This is $0.02 higher than the first quarter of fiscal year '13 and represents an 11% increase.

Turning to slide 4, the business maintained strong gross profit margins. On a non-GAAP basis our gross profit was $66 million, representing an 80.6% margin. Non-GAAP income from operations was $14.1 million, our non-GAAP operating margin for the quarter was 17.2%, which is relatively consistent from the same quarter of prior-year. Non-GAAP net income was $8.7 million or $0.21 per diluted share. The non-GAAP net income margin was 10.6%, again consistent from a year ago.

Turning to slide 5 shows our product revenue composition. Total revenue in Q1 was $81.9 million of which product revenue was $43 million, an increase of $2.7 million or 7% over the prior year's first quarter. The components of our product revenue for the first quarter of fiscal year '14 were as follows. Service providers, $20.8 million or 48% of product revenue; government, $2.1 million or 5% of product revenue; general enterprise, $20.1 million or 47% of product revenue. This compares with the prior year's quarter of product revenue components as follows. Service provider, $17.6 million or 44% of product revenue; government, $4.3 million or 11% of product revenue; general enterprise, $18.4 million or 45% of product revenue.

Slide 6 shows our product revenue growth rates by sector. Service provider continues to lead our revenue growth with product revenue growth of 18% which is driven by our continuing expansion into the carriers and cable companies as they develop their LTE networks and provide increasing services to their customers on those networks. General enterprise grew 9% as we saw growth in our financial services customers, high-tech customers and health care customers. Government declined 51% due to the continuing effects of federal sequestration and cost consolidation. Since the effects related to government were more impactful in our second quarter of last year, Q1 FY '14 is the last quarter with a difficult comparison over the prior year's comparable quarter. At the low end of our guidance, we are assuming that the government spending will be at roughly the same level that we saw in the remainder of FY '13.

Slide 7 shows our total revenue composition. Total revenue in Q1 was $81.9 million, an increase of $5.4 million or 7% year-over-year. The composition of our total revenue for the first quarter of fiscal year '14 was service provider $31.6 million, 39% of total revenue; government, $8.1 million, 10% of total revenue; general enterprise, $42.2 million or 51% of total revenue. This compares with the prior year's quarter's total revenue components as follows. Service provider, $26.8 million or 35% of total revenue; government, $10.7 million or 14% of total revenue; and general enterprise $39 million or 51% of total revenue. Turning to slide 8 which shows our total revenue growth by sector, our total revenue for the service provider sector grew 18% on a year-over-year basis driven by our continuing project wins, our general enterprise sector grew 8%, total revenue for the government sector decreased 25% year-over-year.

Turning to slide 9, this is a depiction of our first quarter revenue by geography. For the first quarter of fiscal '14 the revenue mix between domestic and international revenue of 77% and 23% was generally consistent with our historical averages where domestic revenue is approximately 75% of our revenue and international is the remaining 25%. Within our international sales the mix is also generally consistent with prior results. Europe delivered 11% of our international sales while Asia delivered 5% and the rest of the world delivered the remaining 7%.

Slide 10 includes highlights from our balance sheet. We continue to maintain strong liquidity. At the end of the first quarter of fiscal 2014, we have invested cash, short-term marketable securities, and long-term marketable securities of $162.8 million. This represents an increase of $8.7 million from the prior year's ending balance for cash and short and long-term marketable securities of $154.1 million. Our first quarter fiscal year '14 free cash flow generation was $16.2 million. In the quarter, we continued our share repurchase program and repurchased 250,000 shares for $5.9 million.

Accounts receivable net of allowances was $50.9 million, down from $73.9 million at the end of fiscal year 2013. Day sales outstanding were 55 days for the quarter compared to 68 days for the fourth quarter of FY '13. The day sales outstanding of 55 days for the quarter is 10 days more than the first quarter of fiscal 2013. The 10-day differential in the quarter-over-quarter DSO is the result of the timing of orders and shipments in each quarter. In Q1 FY '14 approximately 80% of our quarterly shipments were invoiced in the second half of the quarter in comparison with approximately 60% being invoiced in the second half of Q1 FY '13 quarter. Inventories were $10.9 million, this is a $3.3 million increase from the fourth quarter of fiscal 2013. Additionally, our total deferred revenue was $117.8 million. This is down from $121 million for the fourth quarter of last year. This decrease is in line with our historical pattern for Q1 as this quarter historically sees lower levels for renewals. Deferred revenue was up 10% from the ending Q1 fiscal 2013 balance.

Turning to our guidance for fiscal year '14, slide 11 illustrates our guidance range for revenue and earnings per share. We are reiterating our guidance for FY '14 for both revenue and earnings per share. Our non-GAAP revenue guidance for fiscal year 2014 is $385 million to $400 million yielding a revenue growth rate of 10% to 14%. As noted on our last quarter earnings call, on our second quarter earnings call of last year, due to the new product introduction and the related sales pipeline generation, our performance and guidance will be slightly more skewed to the second half of our fiscal year. We anticipate that our second half will contribute approximately 56% to 57% of our total revenue at the midpoint of guidance.

Additionally, as we head into the second quarter, I would like to remind you of our service provider sector's lumpy purchasing patterns. For the second quarter of last year service provider new business bookings growth was 117%. This translated into 113% product revenue growth for Q2 FY '13 over Q2 FY '12. We continue to believe that service provider has the ability to be a 20% grower for the Company. However, last year's quarter's performance is not expected to be repeated in Q2 of this year. Therefore, the service provider sector growth on a comparative basis may appear to decline on both a quarterly and year-to-date basis.

Our non-GAAP net income per share guidance for fiscal year 2014 is $1.40 to $1.50, yielding non-GAAP EPS growth of 6% to 14%. As an additional effect of the higher service provider growth in Q2 of fiscal year 2013 that I noted a moment ago, we also experienced increased profitability related to the quarter's customer mix. The customer mix profitability resulted in historically high gross margins and operating margins for the quarter of Q2 FY '13 which we do not believe will be repeated in our upcoming fiscal Q2. The extraordinary margin performance also contributed approximately $0.02 to our reported $0.34 of non-GAAP EPS for the second quarter of last year. This resulted in our non-GAAP EPS skew being approximately 40% for the first half of fiscal year 2013. Adjusting for the $0.02 higher profitability and the revenue skew associated with new product introductions noted earlier we anticipate the non-GAAP EPS skew for fiscal year 2014 will be approximately 36% to 38% for the first half of fiscal 2014.

Additionally, this quarter's non-GAAP provision for income taxes was approximately one percentage point higher at 38%. This was due to the pattern of our quarterly earnings over the fiscal year. We continue to project that our effective non-GAAP tax rate for fiscal year '14 will be approximately 37%. Consistent with past practice, we have used the statutory tax rate of 38% to tax affect the non-GAAP adjustments.

Before we conclude the financial portion of our remarks I would like to inform you of the upcoming conferences in which we will be attending. On August 6 we will be attending the Needham Conference in New York City, on August 12 we will attend the Sterne Agee Conference in Boston, on August 14 we will attend the Oppenheimer Conference in Boston; and on September 17 and 18 we will attend the Credit Suisse Conference in New York City. That concludes our financial discussion this morning. Thank you for joining us and we look forward to taking your questions.

Denise, we will take questions now.

(Operator Instructions)

Alex Kurtz, with Sterne Agee.

Thanks guys for taking a couple questions here. First Jean, when you talk about the government business, I think sequestration really was a big part of this year, but it seems like there's been a structural shift in how that segment has performed for you. Is there something just structurally different now and it is beyond just government cuts? They are just, you are reaching a certain amount of saturation with that vertical?

No, we are not, obviously reaching anywhere close to saturation. It was less than 10% of our business and it is becoming even lower this year. We are not seeing any improvement, but at the same time, there are a lot of interest in our products, including the new one, but just -- so the reasoning is we do not see at least right now any different than last year and certainly it has nothing to do with saturation.

Let me just ask a follow-up and I will jump off the line here, Anil. You guys have talked about midteens type of growth rate for the Company as a target goal. Looking forward. Can you get to those growth rates with government performing the way it has over the last couple of -- the last year or so?

I think we have -- our guidance is what you should look at and that guidance assumes what expectations we have from the government sector, which is continued weakness. We gave the guidance, keeping in mind that there will be further deterioration, maybe even from last year into that business.

Hi Alex, this is Jean. At the low end of our guidance we have anticipated that federal will remain at the same levels that we experienced in FY '13. As we get towards the higher end of our guidance, which as you pointed out is more towards the midteens growth, we would want a few things to happen. One, we would want federal to do slightly better than it did last year. But not to any degree better than it did before cost consolidation and sequestration hit in FY '12. And then there is other factors in there. As you know him our guidance is second half skewed more this year than last year. We would also want the nGeniusONE product to do very well in this year. It has a long sales cycle. Our general sales cycles are six to nine months and we launched it at the end of June but we have had tremendous reception from the customers that have seen it so far, so we are optimistic.

Great, thank you.

Mark Kelleher, with Dougherty and Company.

Great, thanks for taking the questions. I was wondering if you could give us some more insight in the carrier market. There is certainly some thoughts that there is a CapEx cycle underway in the carrier market. How exposed are you to that versus connected to the -- specifically to the 4G and 3G rollouts? Where are we in the cycle of the 4G and 3G rollouts? Thanks.

I think it is part of -- it's somewhere midway through that. Even voice over IP is really the 4G part of the 4G cycle. So I look at the early stages of LTE, our product was most used for troubleshooting and now it is being used for more planning and reporting and trending. And next year maybe more towards business intelligence reporting and market intelligence. The common factor in all three is that we have the common, we have the ASI technology which we -- feeds all three use cases. So while we talk about LTE as more of a monolithic one-time growth rate I think it is a continuing experience and I think we see a lot of opportunities even if the LTE infrastructure is fully deployed. In terms of what people need to do with our product, I think we are still in the mid- stages of that growth.

And you get a sense that the carriers are opening up their wallets a little bit more these days?

We have not seen any -- too much difference from last year, but I think as the new product in the voice area from the acquisition is coming online, we see some growth which we didn't see last year in that area as well.

Okay, great, thanks.

Eric Martinuzzi, with Lake Street Capital.

Thanks for taking my question. In Michael's part of the prepared remarks he talked about an anecdote of a customer who would use the InfiniStreams and nGeniusONE for a large global e-commerce website. Was that just -- curious to know if that was competitively bid, and if so, who was it competitive with?

It was not competitively bid to my knowledge, in the later stages of the deal. But I don't know the answer in more detail at this point.

So that particular customer that Michael mentioned is a prime example of our customer penetration strategy where they were an existing customer monitoring their network. We had had them look at nGeniusONE and they were very impressed and decided to use it for applications and discovered through the testing that the tool was probably the best way to do the convergence of NPM and APM so there was not a need for them to look at other competitors.

Okay.

I think website monitoring is one of the areas which was not fully developed with our previous solution. This deal that Michael talked about came about more because of the nGeniusONE focus on the application side, which indirectly translated into website monitoring for performance and things like that, which traditionally we have not been used in that area.

Okay and the just a follow-up on the guidance. Obviously, a huge back half skewing here is implied in the guidance just based on the percentage first-half versus second-half. You're looking for a 30% revenue uplift and as I do it quarter by quarter, you've got to average about $111 million in the back half versus the $85 million implied in the quarters in the front half. As I look at slide 7, which is the slide that talks about the revenue, the total revenue composition in Q1, does that revenue composition change much for the fiscal year? Maybe even just going down to the product level. In other words, is that back half, that substantial back half growth, what got you here in Q1 is that what gets you there for the fiscal year?

Just to make sure we are talking on the same page Eric, the way I look at our guidance range, at the midpoint of guidance we would have to grow in the second half roughly the 25 -- the uplift over last year would roughly have to be, if I have this right, closer to 15% to 17% just to make sure we are talking apples to apples. In the back half of the year what I think we see is the nGeniusONE product being successful. It will be successful in the general enterprise sector as well as in the service provider sector. And we continue to build the pipeline in service provider, and we continue to have good success so at this point I think we would -- we are reaffirming guidance, where we are confident in our second-half performance.

Okay, yes we are talking about the same numbers. I was just talking sequential half -- second half versus first half and you were talking second half versus second half a year ago. Thank you.

Matt Robison, with Wunderlich Securities.

Thanks for taking the question. First, can you comment on why inventory increased as much as it did?

Yes, primarily because of product platform transition and also because of the new products coming in from, primarily from the packet flow switch, so there are more product lines that we need to stage for and so that is one of the key factors. The second key factor is positioning for growth. And so I believe that the inventory levels will probably level off as we go through these transitions.

Yes, I guess that is a pretty hardware intensive product.

Yes.

So I can see that maybe you -- is it going to have an impact on gross margin?

No. We will be maintaining the gross margin and the initial deployment, we're looking at like Michael is saying some product transition but we had -- anybody who is but a product in the last couple of years, they do not need to refresh the hardware or anything. We do not expect any big issues in that area or in terms of gross margins moving forward.

Just to add on to what Anil said, the gross margin as we talked about on previous calls for the packet flow switch is more hardware-based than it is software-based. To the extent that the composition is more hardware, it does have lower gross margins. So in some quarters where we experience say a higher configuration of packet flow switch technology in our normal products, we may see a smaller deterioration in the gross profit margin. However, it will remain in line with our long-term operating model.

To what degree should we think of the packet flow switch driving that strength in your second half?

I think -- not much different than last year. We do not break it out. The packet flow switch is still going to be a very small portion of the -- it maybe a bigger portion of the growth. But not substantially bigger than overall nGeniusONE growth, but is a small portion of the total. That's why Jean is saying even though the margins maybe lower the aggregate margins will be around the same, at the gross margin level for the Company.

Okay. And Jean can you tell me -- tell us what CapEx and depreciation were?

Sure. For the quarter CapEx -- depreciation was $3.2 million. And amortization was $1.7 million. And CapEx was $2.4 million.

Okay, so the big difference in the cash flow for the first quarter this year versus last year looks like a big, the accrued comp decrease was much more dramatic this year I guess. And that and the inventory would you say.

Well, it is a few things. The cash flow of Q1 of FY '13 we had generated $36 million of free cash flow and about $3 million of CapEx. The cash flow for that quarter was about $33 million of free cash flow. As you know, that's the FY '13 performance over FY '12. During the time period the business grew in the midteens and it's also the usage of backlog, how it came in in FY '12 and how it affected the accounts receivable and especially the DSOs as I noted in my comments. So you did see a large generation in Q1 of working capital. As you mentioned also accrued comp in FY '13 first quarter was a large driver and we also started an employee stock purchase plan in that quarter. There were some one-time anomalies in FY '13 that made the cash flow -- the free cash flow over FY '12 grow more substantially. I don't think the growth in the free cash flow from FY '13 to -- that you saw in FY '13 from FY '12 will occur in FY '14 but we do believe our free cash levels will remain consistent if not slightly higher than FY '13 free cash flow levels.

What should we expect the future tax levels to be for GAAP and non-GAAP?

For non-GAAP we believe that the tax rate for this year will still be around 37%. And the earnings pattern, how the earnings come in, the composition of what we sell and the fact that the Accanto products should probably come in and be starting to be shipped in Q2 or Q3 mostly affects that pattern. Over the long-term we just -- over this year we see it coming down from the 38% that we reported on a non-GAAP tax rate this quarter down to about the 37% by the end of the year.

You recognize the Accanto revenues in Italy I guess? Is that right?

It's more the operating expenses and how they get treated for GAAP accounting. And then all we really do is take the non-GAAP items out at a 38% tax rate. So it's more the accounting of how the tax provisions are supposed to be handled and the results of your foreign operations that skewed it more in this quarter.

What was the regional flavor for your service provider business?

It is still consistent with prior quarters where about 75% of the service provider revenue is still coming from our larger tier one domestic clients.

And book to bill?

We do not calculate that.

So, did backlog grow?

Backlog at this point is below the reporting threshold. It is basically relatively consistent with where it was at the end of Q4 of last year.

Thank you.

You're welcome.

Scott Zeller with Needham & Company.

Thanks. I would like to ask a question looking at previous guidance and then you reiterated the guidance today. Anil, when you first guided for the year saying that it was going to be slightly more weighted to the second half, I believe the last conference call you had mentioned it would be about a 5% shift. When you were formulating that guidance, was there any impact of a pause in customer buying ahead of nGeniusONE? Or was your thinking mostly based on macro?

I think it is not even -- I don't remember mentioning macro conditions being from outside. I think it was more internal that in order for us to drive growth we need to find new opportunities and nGeniusONE by the time it leverages those opportunities will be second half. If we announced it in June it takes a couple of months, but based on the initial interest I think we seem to be guessing right on the impact on second half.

Okay.

I think it's mainly not the macro condition outside. It was more of our own product cycle and where we see the impact.

And just a follow-up on that. Could you just tell us from your own viewpoint what is the single or the top one or two things that are most compelling about nGeniusONE? There was a mention earlier, I think Michael had mentioned it or you about website monitoring. And I wonder just for investors, what is it that you think is most compelling about nGeniusONE versus the older products?

Okay, I will mention something and then plus next time we will have in a few months another investors day which we will announce next time. And at that time we will cover in more detail by that time we would have had some more information on how well it is shaping up. Overall, I think it is very simple. People who are using our wireless solution is proportional to the degree a customer instruments their environment, instrument meaning where to put this meters or agents approach which we call InfiniStream. And previously they were putting it only in places where network performance was an issue. Mostly in those places.

Now they are putting it in places for example in front of the server farm. Not just in front of the routers. Every server farm and there are key sects of server farms, one of the big server farms is the website. And so people are really -- when people are looking at traditional APM, they are simply looking at how the application code is performing, that is a traditional APM solution. But how that is impacted by network, how it is impacted by how the server farm. Today's server farm is like yesterday's -- much bigger than yesterday's mainframe, but it is not a single component. A lot of things can fail.

One of the key portions of the strategy is server farm which is simply there to provide the best application performance. There is no good solution for monitoring those as an entity. That is where we will be selling more InfiniStream. That is one of the big use cases of us going into APM through nGeniusONE.

Thank you. Last question is regarding the financials vertical. Maybe Jean, you can give us some color. I know you're not breaking out separately but can you give us some color about the performance of the financials?

Sure. The performance of the financial sector, or the industry was in the general enterprise sector. It's basically the same trends that we have seen over FY '13 where we have some of our domestic -based financial institutions doing various projects. Either a data refresh or use of our voice and video product. Again, we still see a little bit of signs of life in the international-based financial services but it is still mostly domestic-based financial services that have contributed to growth this year as well as last year.

Should we assume that it was positive?

Yes. It was.

Okay. All right, thank you.

Gary Spivak with ABR Investment Strategy.

A question, I want to follow-up on the backlog question. Is it still your intent to report backlog when it is over what I guess is a $10 million threshold? Is that accurate?

Our intent in general always is to give information that is material and important to the story. You get varying perspectives. $10 million of backlog on a $385 million to the $400 million business is not necessarily that material. Clearly it is an item that we will report in our 10-Ks as required but if it is an important piece of information in any given quarter earnings, we will definitely talk to you about it.

Okay, so we should not think of that as the magic number?

No, I don't think that is the magic number at all.

I think we'll report if it is something really unusual, then we will report it. That is what Jean saying. Not just traditionally, other than what we have to do in the 10-Ks and 10-Qs.

Okay. I want to ask a little bit of the projects that you are seeing in the service providers. Are you seeing them -- you mentioned Vault -- are you seeing them continuing to expand the basic LTE infrastructure? Or have they migrated to new services like Vault and how much of that is driving the service provider versus LTE build out in the tier ones and beyond?

As I mentioned in the past, people look for the future but buy for today. Just knowing that we have a good road map for voice over IP makes them continue to invest in their existing infrastructure, even 3G. I think that is what is happening so they are not necessarily buying 4G right now, they are not there yet, there are TOCs and projects going on. But because they feel comfortable about our direction, they continue to expand their traditional infrastructure and also a lot of solutions that our deployment is going to be shared between voice and data as we go towards these. They might be buying in anticipation of Vault stuff, voice over IP stuff, but not necessarily using it for that right now. I think it's still early stage of deployment. Michael, is there anything?

No, I do believe that there are specific reparations for Vault, where they are starting to spend money. But as Anil pointed out, Vault is only deployed maybe in one specific account, maybe one or two that we know about. That is the data.

Okay. And then if I guess if we look at cloud or cloud service providers, what is going on there? We don't really talk about that as much as we talk about the wireless carriers. Is there the need for these cloud service providers to enhance their performance management capabilities? Are they doing it? Where'd you see -- what is going on there?

Our feeling on -- we look at private and public cloud and many are looking at cloud service provider you're referring to, mostly referring to public cloud. And in those areas, the kind of community being served is a very small number of customers, small size customer. Even Amazon doesn't necessarily have really large customers. And those people are still doing competent management and they are really not good candidates for a solution like ours, the more sophisticated solution like ours. But everyone is building cloud. The government is building clouds, service providers are building clouds and enterprises are building clouds which is just yesterday's data centers. We have a great cloud opportunity but this is a private cloud area. We're really not seeing that service provider cloud public opportunity develop but if it does develop, we will be there. We will be recommended by the parent company who is using it for the private site.

Okay, and my last question is on the traction from the 3900 PFS. What are you seeing with that? Is that performing to expectations? And do you think that segment gets to 10% of revenues by the end of the year or in any quarter by the end of the year?

We will not be able to, like I said, in the quarter, it is just hard to predict but yes we think that will get to that level by the end of the year. But again, we will not be reporting it and it is doing well, better than we thought.

The packet flow switch, Gary, is looked at as complementary or part of our integrated solution. We don't necessarily report on individual products.

Okay, but anecdotally, do you see that as kind of expanding within your footprint and what was the traction? Was there traction in revenues in Q1 with the 3900?

Yes, definitely. In fact it has taken over the lion's share of the revenues from the previous platform. So both platforms are continuing to be part of our portfolio and they are based on the same technology. The 3900 is now the bulk of the revenues.

Okay, thank you.

Sanjit Singh with Wedbush Securities.

I think you are on mute Sanjit.

Sorry about that. Regarding deal sizes, you guys used to break out deals over $500,000, deals over $1 million. If you're not going to break out those exact metrics can you give us a sense maybe in the enterprise market where you are seeing -- if you are seeing any signs of deal size getting smaller or deals getting cut into smaller pieces? Any color on what deal sizes are trending like?

Deal sizes are relatively consistent. We have not really seen them in general enterprise as you mentioned change in shape or size at this point.

Great, and on the competitive environment are there any changes there given the Riverbed OPNET integration? Any easing of the competitive intensity in the enterprise market?

I think if at all it is getting better and like I said later this year we will talk to you about how our NPM plus APM strategy is shaping up. I just want to mention what is happening in the general -- take this opportunity to let everyone know how we see NPM plus APM. Why we call our product nGeniusONE. Because it is one product from one Company. Then you look at NPM and APM solution or server solutions from all of the players including the names we are given. The Company has three products and we are confusing between one product from one Company which is nGeniusONE, versus a Company having solutions for multiple things.

Nobody can buy NPM plus APM products from anywhere except from NetScout. We have a truly integrated product and whereas other companies have products so you have -- you can say Company X has NPM plus APM products but there is no product A product which the customer can buy. Almost like buying two products from two different companies but with the same label. Especially when acquisition happens. And the reason I mention this is this is going to be a big reason for people we hope people who will be buying into this new concept and the ASI technologies behind that. I just wanted to mention because of that reason, we are not seeing any increased competition and hopefully we will see even less moving forward.

Anil I appreciate the commentary. Just to follow-up on that, is there any sense -- in your installed base, traditional NPM type customers, what is the sales process like? Is this a -- is nGeniusONE a complementary to their existing installments or is this more of an upgrade or rip and replace? How does the install base sale work?

Yes, good question. Right now we have been through special in terms in terms of customer satisfaction and investment protection. nGeniusONE has, so there are, nGeniusONE has two parts. One is on the user interface side, which is, basically runs on the same machine as our NPM product, and then there is an ASA technology upgrade which runs on the same place as where InfiniStream is. So, for evaluation purposes, customer does not have to do anything. It is a free upgrade and the hardware upgrade is not required. But once they like it, they will find that they don't have enough of our solution in enough of the places, and we talked about server farm earlier. That's basically the sales cycle is long but it is not as long as hopefully as before. Because it is a very easy way to evaluate without making any investment and once you have a good experience they will deploy in more parts of their infrastructure. Some of it which are never instrumented with NetScout stuff like the website example we had earlier.

That is -- is to -- migrate to customers as quickly as we can within their own interest and limits.

And for my final question just given the consolidation that is going on in the US carrier market do you see any signs of a pause in terms of CapEx projects given what is going on in the US carrier market?

Again we don't -- there's really not substantial -- there is nothing big going on which we think we'll see a pause but I remember when T-Mobile and AT&T stuff was going on, there is a big pause and then there was something else. Somebody was bought by T-Mobile.

That's right.

So we see it a little bit pause, but I don't think there's enough consolidation going on plus we have a big portion of our business that is coming from tier ones and luckily none of that has been impacted by this.

I appreciate the answers, thank you.

Kevin Liu with B. Riley and Company.

Good morning, it sounds like the 3900 has seen good growth in the enterprise market. Was wondering if you could speak to whether there's been any adoption in the service provider market and whether you anticipate that to be a big source of revenues for PFS?

Yes, it is going well there also, but service provider -- look at refresh cycles to do that. It has been a little bit slower because at the last time we were not there. Over enterprise we have better traction than the service provider. But by the end of the year we see some refresh cycles coming up which we will be able to participate in the service providers where we will start seeing improvement, good growth there also.

Okay.

But from a technology standpoint it is totally applicable, same-day is no difference. We see good successes initially there as well.

Just one last one for me. When you look at the 20% plus growth you anticipate in the service provider vertical, given some of the comments around the tough Q2 comp, the 18% growth in this first quarter here on the product side, just wondering what sort of projects you anticipate coming in or what sort of visibility you have into the back half of the year being much stronger for you guys from a growth rate perspective?

I think we have -- the plan looks very good and we are working on several -- very large number of multi million dollar projects. I think that is the main visibility we have. It takes time and I think we feel quite good about the number of projects we are involved in worldwide.

All right. Thank you.

Aaron Schwartz with Jefferies.

Good morning, I just had a few quick questions on revenue concentration. First of all in the service provider segment, is that still somewhat concentrated between 5 or 10 customers? And when you talk about the growth there, is that really growth in sort of the projects you just maybe alluded to, out of those larger customers or are you starting to see expansion to tier two providers? And then secondly, as you look at service provider becoming a much larger part of your overall business, how do you envision that over time? Do think some of the products you released here over the last six months or so well help the enterprise business and bring some diversification the other way in the overall mix between the segments? Thanks.

Maybe if Jean can go over the breakdown, the 40% is not dramatically different than last year. Plus it is not 5 to 10 customers. Yes, in anything, top end customer dominates any business, even in enterprise. But it is not as skewed as you may be thinking to 5, 10 customers. Also I wanted to mention, we are talking about nGeniusONE, but we are also releasing a new product called -- we have a custom product for service providers called Subscriber Intelligence, nGenius Subscriber Intelligence which most of the service providers have bought, but it only works for data, so Accanto product is now going to be coming live this quarter and that same product, and so at that time, I think we will see some traction in that area also. So a lot of the investment we have made in the voice side with the Accanto acquisition will result in additional things beyond nGeniusONE in the service provider area.

Just to follow on Aaron from Anil's comments, as we have talked in the past, the concentration has generally been more weighted towards the domestic carriers. In that concentration, we do supply and service almost every single US carrier. There is a diversification of US carriers that we have. Around the globe we do continue to get new wins. We did get a new win this quarter with one of our international carriers that we are very happy about also. As Anil said, the goal of nGeniusONE and USDM, our Unified Service Delivery Management strategy, is to have the enterprise grow closer to the 10% rates that we are hopeful for over the long-term. These new investments do go into the enterprise, do sell well but because service provider is somewhat complementary and similar at some of its major cores, they also play well into the service provider market also so the packet flow switch, the 3900, as well as nGeniusONE should sell into the service provider over time on a domestic and global basis.

Okay, just a quick follow-up. On the larger Q1 domestic service provider, you've been with these customers for a while and you certainly had a growing presence here. Has your forecasting -- maybe not forecasting, but the predictability, does that improve at all or is this still just a very lumpy business and even at your long-running tier one domestic service providers they can still fall quarter to quarter?

Quarter to quarter, that is why we give the early guidance. I think the predictability quite good over a longer period. And that is what I think we are counting on. That's why you'll see some lumpiness. And whereas something exactly happens in the same quarter, it is not always clear because these things do take time.

Right, so these carriers -- we work on project basis with all these carriers. These carriers all have their own internal projects that they are working, their own timelines. We are cognizant in our pipeline and with our sales group of what projects the customers are working on and where they are going. The timing of those projects when they actually get funded though may come in a quarter earlier or may come in a quarter later which goes to the lumpiness and just the overall complexion of each of these projects, each of these carriers doing different projects at different times also contributes to the lumpiness.

Got it, thank you.

You're welcome.

Mark Jordan with Noble Financial.

Good morning. A question relative to the government sector. With the 25% revenue decline year-over-year. Was that virtually all in the product side and does the service component of your revenues from the government remain relatively stable through this period of pressure?

Yes that is true Mark. As you pointed out, the decline in product was about 50% and the overall decline was only 25%. So again, just to clarify the government position, they still are our customers, they still demonstrate customer loyalty by doing maintenance with us. We still actually have a large pipeline for the government, so the customers themselves that we deal with still have projects and still have demand for our products. There's nothing structurally wrong in the demand and the projects that our customers want us to supply. It does go back to the federal government's ability and decision-making in what they are going to fund.

Okay. Second question relative to nGeniusONE, could you give us a sense as to the revenue impact of an install and what would be the differential between an upgrade versus a green field installation?

That would be very hard to do because -- we are not even tracking that like that. The bulk of the -- there is a green field opportunity and a brown field or whatever want to say. We're going into existing customers and we have opportunities in the department in areas and so green field is defined like that and in those environments it is very hard to keep track of, for example, an application group will buy a product now or server group and then just a networking group. And so we see the bulk of opportunity with existing customer even though technically they are like green field opportunities and because of that it would be very hard to track because they will be using some of the old products from the user interface point, buying new streams. Some will be doing refreshes and moving things around. I think we overall -- you can attribute most of our growth this year to be because of nGeniusONE.

Okay, thank you very much.

You're welcome.

Chad Bennett with Craig-Hallum.

Good morning, thanks for taking my questions. I'm doing great. Can you give us a sense for -- I think if you look back 12 months, the two acquisitions were OpenPath and Accanto. What did they contribute in the quarter?

The ONPATH acquisition is the one that sells the 3900 and they did contribute as part of our solution to some of the growth on a quarter-over-quarter basis. Again, we consider the 3900 to be organic growth. So we don't really break it out separately. The Accanto product is scheduled to be released in this quarter, in our Q2 quarter. So it hasn't really contributed anything at this point. As we develop the voice technology, as Anil said, to go onto one platform so that our customers can buy one product from one company in an integrated solution. We expect that product will be available during Q2 and again, we will be hopefully shipping it in Q3 or Q4.

Okay. And following up on a couple questions about guidance that have been asked, so the revenue growth you saw in the segments, the two main segments this quarter, product revenue growth I'm speaking of, service provider up 18% and enterprise I believe -- general enterprise up about 9%. At the end of the year is that kind of the representative growth rates that you would think -- or that you thought when you gave guidance originally and that you are still thinking today?

Service provider, we have been fairly consistent over the last few years in believing that it would be a 20% grower for us. And the metrics switch from new business bookings is what we were talking about before to revenue. Yes we still believe that it is a 20% grower and we are shooting for service provider to remain that way through the rest of the year. Enterprise, our long-term goal for enterprise is to get the enterprise segment up to 10% or more. With our 9% growth this quarter we are very pleased with that growth. We would like for it clearly to continue through the rest of the year.

So we're in the ballpark, right, this quarter?

Yes we are.

I think Kevin asked the question, I think you implied because of the tough comps, September quarter service provider probably certainly down on a year-over-year on a quarterly basis. And even first half service provider revenue could be down year-over-year. Let's just say it is flat for simplicity, in the first half year-over-year. Second half service provider growth, all else equal, actually has to be more than this because the year is second half weighted. Has to be 40% plus? You guys have visibility, and I know you've been asked this a little bit, do you have visibility in that type of growth in the second half?

I just wanted to, as you had pointed out on the call, I just wanted to caution because sometimes people get concerned when they look at a shorter term measure and our service provider growth over last year was more lumpy than normal. Q2 is probably our largest quarter and on a new business bookings basis at the end of the first half we were up 70% and we trended for the remainder of the year to about 20% to 22%. We still believe this year that we will still grow at the 12 month mark, FY '14 over FY '13 around the same growth rate for the year of around 20%-ish.

Okay.

So the math to get to that will be along the lines of what you indicated.

Okay. And then last for me, in the packet flow switch market, how should we think about your penetration there? I imagine you are going into existing customers first. I am just curious, how will penetrated is Gigamon into your existing InfiniStream customer base? And are you betting on replacing Gigamon in those places, or are you betting on hey, we have InfiniStream customers that don't have any packet flow switches today so we're betting on some green field uptake?

I think we have, first of all coming -- we are looking for 10% market share more in this space, in the packet flow switch space and that could mean -- that kind of number as our overall market share part of our own product line also. That will require us to go into places where Gigamon is there, fully embedded, and again there are two reasons people buy our solution, packet flow switch solution for multiple reasons. One of the reasons is applicable to NetScout, but Gigamon bought the reasons that applicable, so we need to look at how good we are in leveraging some of the opportunities which we are not participating in until, recently until the 3900 switch. To figure out what our uptake will be in those markets.

Is it fair to say in your existing enterprise InfiniStream customer base -- are they pretty well penetrated with, it doesn't have to be Gigamon, but have they adopted packet flow switches already, just in general?

Yes.

Okay, they have.

It will be mostly competitive.

Okay.

We will be going to places where demand is already there so our sales access is going to be one of the challenge but after that it will be mainly computation. So since they have a larger sales force going after this portion of the market it's a little more challenging for us, but overall we are not in the demand generation area, we are in terms of the -- it's mostly based on access, market access, customer access and then competing with other vendors.

Okay make sense, thanks for taking my questions.

Thank you for hanging in there, it was a long call.

Thanks everyone for tuning and we will talk to you again in about three months.

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