Feb 5, 2008
Executives
Anil K. Singhal – Founder, President, CEO & Chairman of the Board David P.
Sommers – Chief Financial Officer & Senior Vice President, General Operations Catherine Taylor – Director Investor Relations
Analysts
Eric Martinuzzi - Craig-Hallum Mark Kelleher – Canaccord Adams Matthew Robison – Ferris Baker Watts, Inc. Peter Jacobson – Brean Murray, Carret & Co.
Manuel Recarey – Kaufman Bros. Scott Zeller – Needham & Company [J.D.
Pagett] – The Boston Company
Operator
Ladies and gentlemen, thank you for standing by and welcome to NetScout’s third quarter of fiscal year 2008 operating results conference call. At this time all participants are in a listen only mode.
Later we will conduct a question and answer session. Instructions will be given to you at that time.
As a reminder this conference call is being recorded. With us today is NetScout’s President and CEO, Mr.
Anil Singhal. He is accompanied by NetScout’s Chief Financial Officer, Mr.
David Sommers. Also with Mr.
Singhal is NetScout’s Director of Investor Relations, Ms. Cathy Taylor.
At this time I will turn the call over to Ms. Taylor to provide the opening remarks.
Ms. Taylor please proceed.
Catherine Taylor
Welcome to NetScout’s third quarter fiscal year 2008 conference call for the period ended December 31, 2007. In terms of the format of this call Anil will begin with an overview of our financial and operating results and David will follow with a review of our financial results and company performance in greater detail.
At the conclusion there will be an opportunity for questions and answers. Before we begin however let me remind you that during the course of this conference call we will be providing you with a discussion of the facts as we currently anticipate that may influence our results going forward.
Such statements are forward-looking statements made pursuant to the Safe Harbor provisions of Section 21(e) of the Securities Exchange Act of 1934 and other Federal securities laws. These forward-looking statements may involve judgments and that individual judgments may vary.
Forward-looking statements include express or implied statements regarding future economic and market conditions, our guidance for the first quarter of 2008 and fiscal year 2009 and our continued integration of Network General. Actual results could differ materially from the forward-looking statements.
Risks and uncertainties which could cause actual results to differ include the company’s ability to integrate the Network General acquisition successfully as well as other factors related to the acquisition generally, the company’s revenues, profitability and growth and delivery and market acceptance of NetScout products. It should be clearly understood that the projections on which we base our guidance and our perception of the factors influencing those projections are highly likely to change over time.
Although those projections and the factors influencing them will likely change we will not 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 calls.
We do not plan to otherwise update that guidance. Actual results may differ materially from what we say today and no one should assume later in the quarter that the comments we make today are still valid.
For the further discussion of the risk and uncertainties that can cause our projections not to be achieved include the specific risks and uncertainties that are discussed in NetScout’s Form 10K for the year ended March 31, 2007 and our quarterly report on Form 10Q for the quarter ended September 30, 2007 on file with the Securities and Exchange Commission. I will now turn the call back over to Anil Singhal, our Chief Executive Officer.
Anil K. Singhal
We are pleased to be reporting good results for the third quarter following our recent acquisition of Network General. The deal closed on November 4th and we booked two month’s of revenue for Network General in the quarter.
We are happy to report that both companies had solid organic growth especially in product revenue. We acquired Network General at a time when they were at a positive inflection point with revenue growing from the newer product line InfiniStream.
This new and growing product line was the basis of our interest in acquiring Network General. NetScout has now more than doubled its size with GAAP revenue coming in at $53.7 million up 103% over the same period last year.
On a non-GAAP basis revenue was $60 million in the quarter up 127% year-over-year. Non-GAAP revenue excludes adjustment to purchase accounting representing the fair value of Network General’s deferred revenue.
Starting this quarter we’ll be reporting GAAP and non-GAAP measures in order to provide a better understanding NetScout’s financial performance, business trends and prospects for the future. We believe that presenting GAAP reserves on their own would not reflect our core operating reserves.
A reconciliation between GAAP and non-GAAP reserves is included in the financial tables in the press release. On the bottom line we posted a loss on a GAAP basis as a result of the acquisition of Network General.
The GAAP net loss was $3.1 million or a net loss of $0.09 per share. However, on a non-GAAP basis we posted net income of $6.2 million or $0.17 per diluted share.
In addition, non-GAAP income from operations was $12.6 million. Non-GAAP net income and income from operations excludes the affect of purchase accounting representing the fair value of Network General’s deferred revenue, shared bid compensation expenses, amortization of acquired intangible assets and inventory fair value adjustment and integration expenses.
We entered the quarter with a strong cash position with cash and cash equivalents balance of $82 million. During the quarter we used approximately $56 million of cash for the acquisition of Network General which includes estimated transactions costs of the deal.
We are confident that cash flows from operations will be sufficient to repair the additional debt we incurred as a result of the acquisition of Network General. With $80 million in cash we effectively have only $18 million in net debt.
On December 31st we refinanced original seller’s debt at favorable terms that provide us with significantly lower interest rates that decline over time as the loan is paid out and other favorable terms including the flexibility to make accelerated pre-payment as our future operating cash flow warrants. This was done with a consortium of banks that gave us good rates based upon the strength of our financials and our prospects for future growth.
We are pleased to report that the refinancing was significantly over subscribed despite the recent turmoil in the credit market. We intend to diligently pay down this debt as more cash flow warrants.
In addition we chose to refinance the debt instead of issuing more equity in order to avoid dilution to our stockholders and to continue our goal to drive earnings per share through. I’m very pleased to report that the integration with Network General has progressed smoothly.
We had laid out an integration strategy before the closing of the deal so that we could begin synergies immediately following November 1st. Thus far we have accomplished the majority of the synergies of approximately $30 million.
We still have more integration work to do and we expect to achieve additional cost synergies from the integration of manufacturing operations during the fiscal year 2009. One of our biggest challenges is the integration of the two accomplished sales team which will happen at the beginning of the fiscal year 2009.
In conjunction with that change we will provide us customers with a unified product portfolio and shortly thereafter we will introduce an integrated solution set combining the best technologies from NetScout and Network General and in the process substantially reducing the cost of ownership for our customers. We’ll be rolling out a model suite of performance management solutions that are intended to protect our customers’ existing product investment and deliver on our promise to our customers to provide them with the most advanced technologies and cost-effective solutions in the marketplace.
However, we recognize that the integration of two companies that are similar in size always presents challenges and we are anticipating some disruption in business as we go through the process. The guidance that David will be sharing with you today for the fourth quarter of the current fiscal year and for the full fiscal year 2009 recognizes those challenges.
In addition we are cognizant of the macroeconomic challenges that are in the news daily about the potential for an economic slowdown and that some companies are concerned about financial sector resulting from the credit crisis. Thus far NetScout has not seen a slowdown in revenue from our financial services customers.
Our products are being deployed in areas such as high-speed trading networks where banks are currently spending their user technology. However our outlook recognizes these logistical and marketplace challenges that we expect to face in fiscal 2009.
In summary the acquisition of Network General has been an historic event for NetScout paving the way for mainstreaming of our unique approach to assuring the consistency of IT services in increasingly network sentry business critical applications. Our combined product portfolio are based on dedicated packet flow instrumentation and offers unparalleled preventive and diagnostic power in the increasing virtualized high end IT environment.
Our joint customers have [inaudible] region and plans and have continued to invest in our solutions. The combined team is energized by the region which is supported by our customers, investors and analyst and is working hard to implement our integration plan and prepare for the challenges of fiscal 2009.
Thank you everyone for your support and we look forward to sharing our accomplishments in the coming quarters. With that I would like to turn the call over to David.
David P. Sommers
Our quarterly financial results are in the financial statements which are part of our earnings press release. Starting this quarter we are now reporting our results not only on a GAAP basis but also on a non-GAAP basis.
We will be removing the GAAP purchase accounting effects of our acquisition of Network General by adding back revenue related to deferred revenue revaluation and removing the cost and expense of various acquisition-related items. In addition we will remove the GAAP effects of stock-based compensation which will be driven principally by the acquisition going forward.
I will give some specifics about the difference between our GAAP and non-GAAP earnings as I discuss our results. The adjustments to GAAP revenue, cost and expense are disclosed in a reconciliation table in the financial tables attached to the press release.
We believe these adjusted financial measures will enhance your overall understanding of our current financial performance and our prospects for the future. We use these adjusted financial measures internally for the purpose of analyzing and managing and forecasting our business.
Our third quarter GAAP revenue was $53.7 million up 103% year-over-year resulting partly from two months of Network General revenue and partly from NetScout organic growth. Non-GAAP revenue was $60 million.
Non-GAAP revenue excludes a $6.3 million purchase accounting adjustment to record at fair value the acquired Network General deferred revenue. Product revenue on a GAAP basis was $36.1 million up 120% year-over-year.
Because the third quarter includes two months of Network General results it is not fully representative of the impact of the acquisition when compared to NetScout’s prior stand-alone quarters. For the same reason the third quarter will not be fully comparable to NetScout’s quarters going forward.
The good revenue results for the quarter and the bookings performance that drives revenue are indicative of initial success in minimizing sales impact from the acquisition and integration process. However, we are cautious about future integration impacts on revenue as I will discuss further.
The GAAP net loss for the quarter was $3.1 million or a net loss per share of $0.09. GAAP loss from operations was $2.4 million.
On a non-GAAP basis net income was $6.2 million or $0.17 per diluted share. The following items are adjustments to arrive at the non-GAAP net income calculation.
The purchase accounting adjustment to record at fair value the acquired Network General deferred revenue of $6.3 million was add back to GAAP revenue. Amortization of acquired intangibles of $1.1 million which was principally from the Network General acquisition was a minor amount of intangible amortization raining from the acquisition of Quantiva assets was removed from GAAP cost and expense.
An inventory fair value adjustment of $1.3 million resulting from the upward revaluation of Network General inventory was removed from GAAP cost. Non-recurring integration expense of $6 million was removed from GAAP expenses.
These integration expenses consist of $2.2 million of severance, $3 million of outside consulting for integration planning and execution support and $821,000 of office lease restructuring, inter-employee retention and other non-recurring expenses and share based compensation expense of $343,000 was removed. The total of non-GAAP adjustments to pre-tax income was $15 million.
To calculate non-GAAP net income we’ve used the statutory tax rate of 38% to tax effect the $15 million total non-GAAP adjustment amount removing $5.7 million from non-GAAP net income. These adjustments are summarized in the reconciliation table included with our press release financial statements as I mentioned.
Our GAAP gross profit for the quarter was $38.1 million. GAAP gross margin was 71% in the quarter.
On a non-GAAP basis gross profit was $46.9 million and non-GAAP gross margin was 78%. We made the following adjustments to non-GAAP gross profit: $6.3 million was added back to revenue, e removed $17,000 of share-based compensation expense, $768,000 of amortization of acquired intangibles, $1.3 million of inventory fair value adjustment and $438,000 of non-recurring integration expenses.
GAAP loss from operations was $2.4 million. Non-GAAP income from operations was $12.6 million.
We made the following adjustments to non-GAAP income from operations: the same $6.3 million was added back for revenue, we removed $343,000 of share-based compensation expense, $1.1 million of amortization of acquired intangible assets, $1.3 million of inventory fair value adjustment and $6 million of non-recurring expenses. As with revenue due to the transient effects on cost and expense of the inclusion of two months of Network General operating expenses in our gross profit and operating profit results our non-GAAP profit results will not be fully comparable with future quarters.
Turning now to key balance sheet measures tangible market securities were $81.9 million down from $108.9 million in the previous quarter. We used approximately $56 million for the acquisition of Network General and we acquired $26 million of cash from Network General.
Factoring out the effects of the acquisition transaction our cash and marketable securities grew $3 million in the quarter. Accounts receivable net of allowances were $48.5 million compared to $18.7 million last quarter.
Days sales outstanding were 69 days for the quarter based on GAAP revenue using non-GAAP revenue DSO were 63 days. This is up from 58 days in the prior quarter.
Because of the acquisition and the increasing international component of our revenue we’re increasing our DSO target range by 5 days to 50 to 60 days. Inventories were $10.2 million up from $4.6 million in the prior quarter due principally to the increasing complexity of managing multiple product lines across multiple manufacturing organizations and locations.
We are working now on the integration of the InfiniStream product line into our Westford manufacturing operation. That integration will take place during the first half of fiscal 2009 and will allow us to reduce inventory levels in relation to revenue and improve manufacturing margins over the course of the year.
Turning now to other financial metrics revenue contribution from direct customers was 40%, reseller revenue made up the balance. Revenue from international sales was 29% of total revenue with Europe, Middle East and Africa at 19 points, Asia at 6 points, Americas outside the U.S.
was 4 points. The strength in AMEA is driven by our increasing penetration of the wireless service provider market outside the U.S.
With the Network General acquisition the number of new customers has increased significantly principally due to the portable Sniffer business which has a large number of small customers. Because that business is significantly different than NetScout’s principally large customer business and because we now have a much larger customer base we will not be discussing new customer additions as we have in the past.
We saw a significant increase in large deals in the quarter. 137 customers gave us orders over $100,000 including 26 customers with orders over $500,000 and 12 orders over $1 million.
Five of the $1 million deals came from customers in the financial services industry including two commercial banks, two investment banks and a trading exchange. Four of the $1 million deals came from customers in the telecom industry specifically wireless service providers.
With the acquisition we now have all of the top five U.S. wireless carriers as customers.
We also saw a $1 million deal from a wireless service provider in Nigeria which has deployed a sophisticated 3.5G network that is offering video calls. This is a significant new penetration into the African market which is indicative of the potential for expansion of our wireless business around the globe.
Summarizing our business by vertical market this quarter we had strong bookings coming from the telecom sector representing 28% of dollar order volume which is an all time high for the sector. These large orders coming in from this sector has skewed our other vertical markets downward.
As a result we had 27% of orders coming from financial services sector which is traditionally greater than 30% and we saw 12% coming from the government sector. The high-tech and medical vertical sectors followed with 6% each.
As a result of the acquisition of Network General we now have 823 employees. This is up from 378 employees prior to the acquisition in the September quarter.
At the end of December we had achieved the majority of the cost and expense synergies largely through headcount reductions that we had planned at the close of the acquisition. The financial impact of these changes and of the marketing programs and facilities reductions that we are making will phase in over the next few quarters but they have begun to show results.
There were approximately $2 million of savings in the third quarter. When all synergy implementation is complete we expect to have fully achieved our plan of $32 million of annualized savings.
Now to guidance; as Anil mentioned earlier we are issuing guidance today for the fourth quarter of fiscal year 2008 as well as the full year of fiscal year 2009. Our guidance for the fourth quarter includes a full quarter of revenue and expenses for Network General.
We expect the fourth quarter revenue results to be slightly higher than the third quarter although dampened as Network General’s sales force transitions into its former fiscal first quarter traditionally the weakest quarter. Previously Network General’s fiscal and quota year had ended on January 31st.
For the fourth fiscal quarter of 2008 we expect GAAP revenue to be in the range of $54 to $58 million and GAAP net loss per share to be in the range of $0.18 to $0.22. On a non-GAAP basis we expect revenue to be in the range of $60 to $64 million and non-GAAP earnings per diluted share to be in the range of $0.04 to $0.08.
The fourth quarter of fiscal 2008 non-GAAP revenue and earnings estimates exclude a purchase accounting adjustment to fair value of approximately $6.3 million of Network General’s deferred revenue, amortization of acquired intangible assets of approximately $1.8 million, integration expenses of approximately $5.4 million and share based compensation expenses of approximately $1.3 million. Now to the outlook for fiscal 2009; our revenue guidance for fiscal 2009 recognizes the logistic and market challenges we are facing as we continue the integration process.
We are planning to combine and reorganize our sales forces early in the new fiscal year. In addition we will be introducing new integrated products to the market early in the fiscal year and we are taking into account a normal customer lag in new product adoption as we make the product transitions.
For the fiscal year we expect GAAP revenue to be in the range of $250 million to $260 million and GAAP earnings per diluted share to be in the range of $0.08 to $0.18. On a non-GAAP basis we expect non-GAAP revenue to be in the range of $260 to $270 million and non-GAAP earnings per diluted share to be in the range of $0.50 to $0.60.
The fiscal year 2009 non-GAAP revenue and earnings estimate exclude a purchase accounting adjustment to fair value of approximately $11.2 million of Network General’s deferred revenue, amortization of acquired intangible assets of approximately $6 million, integration expenses of approximately $1.5 million and share-based compensation expenses of approximately $6.9 million. We are also announcing a change to our practice of issuing quarterly guidance effective in fiscal 2009 which is a new practice being adopted by other companies as well.
We will be issuing only annual guidance going forward. In each successive quarter we expect to comment on the full year guidance; however we will not give guidance for individual quarters.
We are making this change because we believe that the excessive focus on short-term results distracts management and investor attention from more important long-term trends, risks and opportunities. With our increased scale and market presence we will be focusing more strategically on those long-term issues while we continue to manage our business internally to appropriate short-term milestones and financial targets.
That concludes our financial discussion this afternoon. Thank you for joining us and we look forward to taking your questions.
Operator
(Operator Instructions) We will pause for just a moment to compile the Q&A roster. Your first question comes from the line of Eric Martinuzzi from Craig-Hallum.
Eric Martinuzzi - Craig-Hallum
Fiscal 09 you’re at $250 to $260 million non-GAAP on the revenue and that’s up from your prior forecast of the doubling of the run rate from September 07 which implied I think around $237 million, if I’m not mistaken. Could you address what the drivers are on the upward revision?
David P. Sommers
We didn’t hear the first part of your question, but I think it was that we’ve gone from doubling of revenue of about $30 million which could be the $29.6 million spread across the fiscal year which could be interpreted as 237 up to 250 to 260. So forgive me if that’s redundant.
Eric Martinuzzi - Craig-Hallum
No, that’s correct.
David P. Sommers
When we gave the guidance which we gave last September we had a view of what the impact the integration expense of the integration process would be. That as we have gone through the acquisition and integration process since then we have refined and the 250 to 260 on a GAAP basis is a modest increase because we have seen a good response from customers as Anil mentioned and so we have moderated slightly our caution about the dampening effects that we still expect to see as we integrate sales force and reassure customers of our investment protection of their existing installations.
So it’s really in our view consistent with what we said, a slight upward modification.
Anil K. Singhal
I think going on, Eric, like David said that we see, I guess we were more conservative on that disruption side but as we’re getting customer feedback and as we did close a very good quarter we are feeling much better about doing the numbers we just talked about.
Eric Martinuzzi - Craig-Hallum
Assuming we use a January close for the Network General, what was the implied pro forma organic growth rate for the quarter just ended?
David P. Sommers
I’m sorry. Can you rephrase that?
I didn’t quite understand what you’re asking.
Eric Martinuzzi - Craig-Hallum
When you closed the transaction you gave kind of a September 07 pro forma number sort of a six months ended. What I was asking was if we go and just look at the most recent quarter on that same pro forma basis what was the implied pro forma organic growth rate on a non-GAAP basis?
David P. Sommers
I actually don’t have that number here. We had not planned to be talking about the pro forma, the current results against our pro forma.
I think it’s fair to say though – So I don’t have a specific number however, it’s fair to say that both companies saw organic growth, both companies experienced good demand. Our organic growth from on the NetScout side was stronger than we had thought it might be at the beginning of the year and I’m sorry I don’t have a specific number for you.
Eric Martinuzzi - Craig-Hallum
It’s all good, it’s in the right direction. And then one last if I might, the gross margin non-GAAP 78%, that’s well above what I was expecting for the combined entity.
Can you help us out with where that heads over time?
David P. Sommers
I think you will see from the guidance for Q4 that it’s going to take a dip in Q4 and that has to do with the effects we expect to see on revenue and the flow through in Q4 versus Q3 and the flow through of the fixed variable dynamic in gross margin in Q4. If you think about two months of revenue from Network General in Q3 and three months of revenue in Q4 and revenue run rate on a non-GAAP basis going up slightly we expect to see in the short term a decline in gross margin of several points.
Over the long term, however, we expect that the acquisition will enable us to continue to hit our, or perhaps exceed, our gross margin targets of 73 to 78% that we NetScout had historically had. We’ve mentioned that we are going to be doing this manufacturing integration which will allow us to bring the key InfiniStream product line into the NetScout manufacturing process which we believe will improve margins going forward.
But that’s going to take place over the first half of fiscal 2009. So you’ll see a drop in Q4 and then steady improvement over fiscal 09.
Operator
Your next question comes from the line of Mark Kelleher from Canaccord Adams.
Mark Kelleher – Canaccord Adams
Had a couple of questions, I might have missed this but can you break out what Network General contributed in revenue in the quarter for those two months?
David P. Sommers
Mark, we’re not going to be doing that going forward. So, the answer is no.
The reason is the businesses are increasingly being integrated and mixed and although we could for a short while say, “Well here’s what the Network General product line contributed.” Because it is still tracked separately very soon that’s going to be meaningless.
So we’ve made the choice not to start doing that and then have to say in a quarter or so we can’t do it anymore because it doesn’t make any sense. I apologize.
I know it doesn’t make it interesting, but we can’t do it.
Mark Kelleher – Canaccord Adams
So it doesn’t make sense to just kind of break it out where it was only part of the quarter.
David P. Sommers
No. I’m afraid we’re not going to be able to.
Anil K. Singhal
And also we are making both products available to NetScout customers so it’s not a true indicator of NetScout versus Network General business anyway because they have choice of two products versus one and they probably are making a different decisions than they could have made in the past because of the choice. So that’s another reason why it doesn’t make sense.
Mark Kelleher – Canaccord Adams
Network General had seasonality strength into the end of the January quarter. Is that right?
And that’s kind of mitigating into the next quarter?
David P. Sommers
That’s correct. Their quota year ended January 31st and that as with most technology businesses is a strong quarter for them.
Starting February 1 they enter their weak quarter which is one of the significant mitigating factors in our outlook for Q4.
Mark Kelleher – Canaccord Adams
So it would be safe to assume that you got off to a good start in your first month of your March quarter from Network General?
David P. Sommers
That would be a logical conclusion. Yes, Mark.
Mark Kelleher – Canaccord Adams
Turning over to the Sniffer can you break that out as a percent of revenue or can you tell us some of your plans for the Sniffer product going forward?
Anil K. Singhal
I think the plans are that 80% of the revenue comes from the product line which is called InfiniStream. InfiniStream directly or indirectly responsible for 80% of the revenue or higher.
And that’s a product that will be –
Mark Kelleher – Canaccord Adams
Specifically the portable product?
Anil K. Singhal
Oh, you’re talking about portable?
Mark Kelleher – Canaccord Adams
Right.
Anil K. Singhal
I think we are not [inaudible] the product revenue in that area was sort of insignificant but we will continue to count on it in the revenue stream from that product moving forward.
David P. Sommers
The portable Sniffer product and the DSS product, revenue has been declining although they are a large install basis out there which we’re going to continue to support and provide normal maintenance renewal and support for going forward. As Anil said, the Sniffer and distributed Sniffer products are really not too significant in the overall revenue stream any longer.
Operator
Your next question comes from the line of Matt Robison from Ferris Baker Watts.
Matthew Robison – Ferris Baker Watts, Inc.
Anil, did you say 18 or 80%?
Anil K. Singhal
80. 80.
Matthew Robison – Ferris Baker Watts, Inc.
80. How does that compare to AFMon sales?
Anil K. Singhal
I think it’s significantly higher. Basically there are three products.
NetScout has a pro product which is its flagship product which is still the biggest portion of revenue and some of the probe business was migrating to AFMon which was a much smaller portion. Whereas in the case of natural [inaudible] the DSS line was declining.
Both those areas are covered by a single product called InfiniStream. InfiniStream and AFMon will be merged into a single solution from a software point of view very soon and basically there will continue to be growth revenue but as a result of NetScout having two products called Probes and AFMon and [inaudible] really having InfiniStream product because of the decline of DSS, InfiniStream revenue was significantly higher than AFMon.
David P. Sommers
That 80% statistic is product revenue split.
Matthew Robison – Ferris Baker Watts, Inc.
Do you guys intend to break out stock comps by expense category going forward?
David P. Sommers
Yes. Yes.
We will show that on the income statement so you can see which line items the stock expense applies to.
Matthew Robison – Ferris Baker Watts, Inc.
Do you care to offer it for the quarter we’re talking about today?
David P. Sommers
I don’t know whether we have that here or not. It doesn’t look like we’re prepared with that here.
We might be able to get it for you before the end of the call, however.
Matthew Robison – Ferris Baker Watts, Inc.
That would be great. How is the IT integration going?
You guys compatible information technology or are you having to do something duplicitous in that?
Anil K. Singhal
We were both on Orcale in terms of the Sierra system and everything but overall there was no big difference. Sales automation system were different but we’ll be able to integrate a lot of the – I guess you’re asking what tools when you talk about IT.
I think it’s not an easy task but I think it’s going much simpler than some other companies where it is a totally different system to start with.
Matthew Robison – Ferris Baker Watts, Inc.
The book to bill, given what you’re facing with the fiscal year and the seasonality for NG, should we assume that the book to bill was less than one for the quarter?
David P. Sommers
We don’t comment on backlog or bookings so we really can’t answer that question directly. However, we had a good quarter, good bookings.
Anil K. Singhal
Plus they’re not being affected by the IT system integration.
Matthew Robison – Ferris Baker Watts, Inc.
Was that $3 million was that the equivalent to operating cash flow or was it more like a free cash flow number?
David P. Sommers
The $3 million was a cash balance increase so it’s really none of those.
Matthew Robison – Ferris Baker Watts, Inc.
Can you provide operating cash flow and cap ex?
David P. Sommers
We can give you cap ex and depreciation in one second. For the quarter depreciation expense was $1.7 million, $900,000 was cap ex.
You’ll see shortly in our 10Q you’ll see the full operating cash flow but because of the acquisition part of the cash flow statement is a little unrepresentative of the increase. A lot of puts and takes to get to the $3 million, simpler for us just to focus on that.
Matthew Robison – Ferris Baker Watts, Inc.
What areas do you expect to be investing in in the near term?
David P. Sommers
You’re talking about overall product development investments or anything in particular?
Matthew Robison – Ferris Baker Watts, Inc.
No, not anything in particular just in general.
Anil K. Singhal
First of all we have a good team in place if you’re talking about people, headcount, technologies. We are in very good shape.
But we think a combination or two of technologies can open up new applications and new areas of growth for our business either in terms of what other things we can do for the IT organization or in different verticals that we talked about. There’s a lot of scope in wireless service providers and all those.
I think we’ll be leveraging many of the investments which are already in place to go after those opportunities but really there is no big investment targeted beyond what we have done moving forward for fiscal year 09.
Matthew Robison – Ferris Baker Watts, Inc.
You mentioned your sales force integration is early in the fiscal 09?
Anil K. Singhal
Our quarter year ends in March and integration will happen by the end of March and after March 31st we’ll have a single integrated sales force.
Matthew Robison – Ferris Baker Watts, Inc.
I’ll let somebody else ask a question.
David P. Sommers
Before you go we have the stock based comp line item numbers. R&D was 80, sales and marketing 152, G&A $94 and cost 17 and that adds to the 343 that we mentioned, the stock comp that we removed to get to non-GAAP.
Operator
Your next question comes from the line of Peter Jacobson from Brean Murray.
Peter Jacobson – Brean Murray, Carret & Co.
Just a clarification, you said 80% of the Network General related product revenue comes from InfiniStream. Is that correct?
David P. Sommers
Yes.
Anil K. Singhal
What I meant was directly or indirectly. As you know NetScout sales AFMon product was always sold with the application called Performance Manager so it’s similar to that InfiniStream has other software models attached to it but they’ll be used less without the InfiniStream box.
InfiniStream is directly or indirectly responsible for that much of the product revenue.
Peter Jacobson – Brean Murray, Carret & Co.
So the 20% remaining is that associated with legacy products?
Anil K. Singhal
The legacy products are some products which we may not put a lot of focus on. It’s a combination of those.
Peter Jacobson – Brean Murray, Carret & Co.
And the 20% is expected to decline sequentially over upcoming quarters?
Anil K. Singhal
No, some of it will be replaced, some of it will decline, some of it will be replaced by other products which NetScout is planning to announce.
Peter Jacobson – Brean Murray, Carret & Co.
What’s the mix between product and services for the Network General business roughly?
David P. Sommers
As you could see in the historical financials it’s been pretty close to a 50-50 mix, historically and as revenue grows organically as it did in both product lines typically that makes swings more toward the product side because that’s clearly what grows first. So you can assume that the product revenue was a little bit larger than the service revenue.
Peter Jacobson – Brean Murray, Carret & Co.
And earlier I believe you said that both the traditional NetScout and the Network General business in the quarter experienced growth. Were you referring to year-over-year growth or sequential or both?
David P. Sommers
Both.
Peter Jacobson – Brean Murray, Carret & Co.
The $7 million to be saved annually associated with the 35 headcount cut scheduled for the end of March is that associated with the sales force integration? Has any of that been completed at this point?
David P. Sommers
No, it’s not really sales force related. It’s really related to the teams of interim people from Network General that we have asked to stay on to help us do the ongoing integration but the sales force isn’t really the focus of them.
It’s really the IT systems, the financial systems, financial process, manufacturing process integration where most of those folks are. The people who are helping us out all have retention plans in place so the planning, the agreements are all done but the interim process is continuing so the execution is not yet done.
Peter Jacobson – Brean Murray, Carret & Co.
So you’re still looking to accomplish that by the end of March
David P. Sommers
Yes, in some cases there’s some people who will stay on past that for various individual specific reasons, but most of it by the end of March, yes.
Operator
Your next question comes from the line of Manny Recarey from Kaufman Bros.
Manuel Recarey – Kaufman Bros.
When you talk about the annual savings of $32 million you realize there’s $2 million of that in the third quarter you said, so to get that $32 million you have to kind of rate that to about $8 million on a quarterly basis, so is that going to be to further headcount reductions? Can you just explain to me how you’re going to get to that level of cost savings?
David P. Sommers
The way to think about that is November 1st, as Anil had mentioned, we had a plan that was in place and we started to execute it, that’s of course one-third of the way through our December quarter. And across the course of the month of November we notified people and reached agreement with people on interim plans and through the month of November and into December people began to leave as agreed.
The savings synergies were realized over the course of the initial prompt of them over the course of the quarter. You won’t see a full run rate visible in the quarter.
You will see that run rate for everything that was done in November, December in Q4. You’re right, $8 million is our quarterly target and you can see the two-thirds of that we have been saying we have achieved through what’s actually been implemented but you don’t see $6 million or $5 million of savings yet in the synergies because of the phase implementation.
Manuel Recarey – Kaufman Bros.
Comparing the guidance you had talked about disruptions when you first made the announcement of the acquisition. Has anything changed in your outlook as far as with the sales integration and customers reacting to the merger and so forth?
Are there any changes in our outlook?
Anil K. Singhal
There was an earlier question about that we seemed to have raised the guidance of what we are talking about beyond two times of the net gross revenue which we talked about earlier and that’s coming from much more product support from customer base. The customer disruption is actually less than what we had thought.
In other areas, finance and G&A and all those it’s about the same and in the sales area we are expecting to be about the same as we thought but it remains to be seen over the next couple of months as we put that into execution.
Manuel Recarey – Kaufman Bros.
If I could just have one more question on a different matter. I saw that HP is talking a new upgrade to their network node manager and a software add on that they’re going to introducing soon.
I think it’s called the SPI for performance. I was just curious, is that going to have any impact on NetScout at all?
Just your view on that?
Anil K. Singhal
I don’t think [inaudible] positive impact and we are not ready to announce what role we play in that but we certainly see a negative impact of that. It really doesn’t go after the product we are going after.
Hopefully we can share some of that with you during the next call.
Operator
Your next question comes from the line of Scott Zeller from Needham & Company.
Scott Zeller – Needham & Company
Question on sales, we’ve already discussed on the call that the integration of sales will take place in the March time frame. I was wondering though at this point can you give us some color where things stand with the leadership in sales and if you had departures, are you happy with who is currently in place in senior roles for sales?
Anil K. Singhal
I think basically we cannot talk about all the details which are that this not been exposed to the people. From the management point of the integration is going very well.
We have almost everyone excited about moving forward we wanted to retain. I think organization and other planning is coming very well but there is still a lot of work ahead in March in terms of quota and things like that.
Scott Zeller – Needham & Company
The other question is regarding, we’ve heard a lot about the effort to tailor your offering to the wireless provider community and we also have heard recently about the efforts to do the same thing for the financial services community, the trading organizations. Can you tell us where you stand with that targeting the trading organizations?
I wasn’t able to tell from when we last talked about it if it was actually out and active in the field. You had a good quarter for financials.
Wanted to just get an update.
Anil K. Singhal
In both the cases what is out in the field are independent offerings. We have an offering both for the trading organization as well as wireless service providers but they are currently individual offerings.
In one area there is some overlap between it to reduce and another area we need those offerings are complementary and we need to combine them and integrate them. The integrated product we are talking about which is next quarter and following that is really going to fully deliver on that promise.
What we talked about, what is already selling is individual products either as a Network General offering or as a NetScout offering.
Scott Zeller – Needham & Company
I wasn’t clear with that. I apologize.
What I really meant was I couldn’t get a sense from when we spoke earlier how long the trading floor targeted offering was really being offered in the field? Has it been in place for a couple quarters now?
How long have you had it active in the field?
Anil K. Singhal
It’s like a couple of quarters but it has been maybe a couple of quarters for Network General and maybe a quarter or so for NetScout but it has really not gone into the mainstream because it was a work in progress. So we’ll see a bigger impact on that in the fiscal year 09 than we saw in 08.
Operator
(Operator Instructions) Your next question comes from the line of [J.D. Pagett] from The Boston Company.
[J.D. Pagett] – The Boston Company
A couple quick ones; one, just what would be share count we should be thinking of going forward? And the tax rate?
David P. Sommers
Share count for the quarter is about 36.5 and that’s going to go up toward about 39 as we go into Q4 because of the issuance of 6 million shares to the sellers of Network General. And your other question was?
Sorry.
[J.D. Pagett] – The Boston Company
Just the tax rate? It looks like the non-GAAP tax rate from this last quarter was up in the mid 40% if I was doing the math right.
David P. Sommers
Have to get some help here on that.
[J.D. Pagett] – The Boston Company
I just took the 12.6 million of non-GAAP EBIT and subtracted the $1.2 million of interest expense and then you drop $6 million and change on a net basis from that?
David P. Sommers
That sounds right. The way we’re doing this is calculating our GAAP provision from our tax position and then using the statutory 38% rate to calculate the tax to remove from the non-GAAP income and because our GAAP provision is below 38% that’s simplifying calculation because we’re not doing a whole new non-GAAP tax provision calculation.
That simplifying calculation will result in high non-GAAP tax provision rates which is what you’re seeing. Now the reason we’re doing that is because a non-GAAP tax provision is kind of meaningless because you don’t have the underlying support of how the credits and the expenses really relate to the non-GAAP P&L.
So just for simplicity sakes, so that everybody can understand it, we’re saying 38% on the non-GAAP adjustments and let the provision fall where it may. Isn’t that clear?
[J.D. Pagett] – The Boston Company
Maybe. But for the purposes of computing non-GAAP EPS in this current quarter for instance of whatever you said, $0.04 to $0.08, what should be using?
We come up with our estimate of non-GAAP EBIT and then some interest expense and we get non-GAAP pre-tax. What’s the tax rate we should apply against that to get non-GAAP EPS?
David P. Sommers
The way to do it is to take the GAAP numbers and you’ll have the provision and you can use that provision, you can assume that the GAAP provision is reasonably stable and then look at the adjustments between GAAP and non-GAAP and use the 38% rate on that and see what the combined resulting rate is.
[J.D. Pagett] – The Boston Company
Okay. So come up with a GAAP estimate first?
Use the provision on that?
David P. Sommers
Right. And you can assume that because our GAAP tax provision methodology as most peoples’ are, is relatively stable, we look at an annual rate and we adjust it quarterly.
So it should be, unless something significant changes in our tax posture, should be relatively stable.
[J.D. Pagett] – The Boston Company
Historically that’s been what, around 30%. Right?
David P. Sommers
Yeah, in the low 30s.
[J.D. Pagett] – The Boston Company
And that doesn’t change with anything we’re talking about here?
David P. Sommers
No. It will change over year-to-year but within a year it should be pretty stable.
So that methodology we talked about should work reasonably well for the non-GAAP provision.
[J.D. Pagett] – The Boston Company
And then the final question just to save me the headache of doing the math, what would be the interest expense in a full quarter with the current financing?
David P. Sommers
We’ve got about $100 million of debt out and our debt is at about 300 basis points over LIBOR and LIBOR is around 5, a little less. Let’s call it 8.
That’s $8 million a year divided by four is about $2 million a quarter.
[J.D. Pagett] – The Boston Company
And then you have the interest in –
David P. Sommers
It’s a little high. But that’s to get you in the right ballpark.
[J.D. Pagett] – The Boston Company
Then you have the interest income offset from the cash?
David P. Sommers
That’s correct which yields a lower rate than the [inaudible]. Right?
[J.D. Pagett] – The Boston Company
But the cash we see at the end of the period here, the 52 plus the 29 that’s reflecting everything you paid out for the acquisition?
David P. Sommers
That’s correct. And, one thing I should say is we do expect, if we continue to perform as we did in Q3 and we expect to going forward, that we will be stepping down the margin with the debt offering over time.
Those interest rates, as Anil mentioned in his remarks, will be coming down.
[J.D. Pagett] – The Boston Company
That’s because of refinancing or because you’re paying it down?
David P. Sommers
Because the interest margin in the debt decreases as we pay down the debt and as we increase non-GAAP EBITDA. You’ll see in the debt filings as that leverage ratio improves so there’s less leverage the margin goes down and of course whatever LIBOR does is what LIBOR does.
Operator
At this time there are no further questions. I will turn the call back over to Mr.
Sommers for closing remarks.
David P. Sommers
Thank you all very much for attending our third quarter earnings call. We’ve really appreciated the good attendance and the good questions and we look forward to speaking with you again toward the end of April, beginning of May at the time of our fourth quarter earnings call.
Thank you and good night.
Operator
This concludes today’s conference call. You may now disconnect.