Opiant Pharmaceuticals, Inc.
Q3 2008 Earnings Call Transcript

Published: 5 Feb 2008

[Operator:]

Greetings, ladies and gentlemen, and welcome to the OPNET Technologies fiscal year 2008 third quarter investor call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Mr. Marc Cohen, Chairman and Chief Executive Officer for OPNET Technologies. Thank you Mr. Cohen, you may begin.

[Marc Cohen:]

Thank you. Welcome and good afternoon, I am Marc Cohen, Chairman and CEO of OPNET Technologies. Before proceeding let me note that various remarks that we may make about future expectations, plans and prospects for the company constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. These include statements regarding the company's or management's intentions, hopes, beliefs, expectations or predictions. Because such statements deal with future events, they're subject to various risks and uncertainties and actual results could differ materially from the company's current expectations. Factors that could cause or contribute to such differences include, but are not limited to, fluctuations in customer demand, the company's ability to manage its growth, risks associated with competition and risks identified in the company's Securities and Exchange Commission filings, including those appearing under the caption certain factors that may affect future results in the company's Form 10-K for the year ended March 31, 2007 and our quarterly report on Form 10-Q that we will file during fiscal 2008. While we may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our views change. Therefore you should not rely on these forward-looking statements as representing our views as of any date subsequent to today. During this call we may also refer to non-GAAP financial measures. A reconciliation of any non-GAAP financial measure to the most directly comparable GAAP measures would be available in the Investor Relations section of our website, www.opnet.com. I am pleased to report a record quarter for fiscal Q3 ended 31 December, 2007. We generated a record $26 million in revenue and ended the quarter with record deferred revenue of $26.5 million. This resulted in an operating margin of negative 9% and earnings per share of negative $0.06. Our cash, cash equivalent and marketable securities balance decreased by $11.5 million from last quarter to $81.8 million. As we discussed during our last earnings call we completed the acquisition of certain assets of Network Physics in October of fiscal Q3. This acquisition is strategically significant to OPNET for several reasons. First it accelerated our delivery of our previously announced appliance for real-time application performance monitoring called ACE Live. Second it brings OPNET a significant base of new customers through which we can sell our existing solutions. Third it created a solution suite which is unique in the industry in terms of its power to address end-to-end application performance management. Our presentation today will have three parts. First, Mel Wesley, CFO will review the financial results of the quarter. I will then discuss our business performance for fiscal Q3. We will conclude with a question-and-answer session. Alain Cohen, our President and CTO will join us in answering your questions. Now, I would like to hand it over to Mel Wesley.

[Mel Wesley:]

Thank you, Mark. Q3 was a record quarter for OPNET, which was driven by record sales to corporate enterprise customers. We generated $26 million in quarterly revenue while increasing deferred revenue to $26.5 million. The Network Physics asset acquisition completed in October accelerated our release of ACE Live, which contributed revenue during the quarter and enhanced our application performance management portfolio. The acquisition did put pressure on our operating income and decreased our cash and marketable security balance. Our operating income decreased sequentially from positive $211,000 to negative $2.3 million. Our cash and marketable securities balance decreased sequentially from $93.2 million to $81.8 million. Given our strong sales pipeline, revenue visibility and enhanced growth opportunities, we believe we are now in a stronger position to increase profitability. Before proceeding with Q3 financial measures, I would like to discuss two matters. First, I would like to expand on our effort to increase profitability. Based on revenue growth and cost management initiatives we have in place, we are establishing the following operating margin goals. We believe we can achieve a quarterly operating margin of 7% to 10% by Q4 of fiscal 2009 and a quarterly operating margin of 15% to 19% by Q4 of fiscal 2010. Our projected target models outline both of these operating margin goals are included as part of the Exhibit 99.1 on our Q3 earnings release. Second, I would like to note that our Board of Directors has authorized an increase of up to 1 million shares under our stock repurchase program. The increase reflects our ongoing commitment to improve the investment value of our stock, while at the same time growing our business and profitability. Now I will summarize the financial performance for the quarter. First, overall execution by our sales team significantly improved over last quarter. Revenue in Q3 was $26 million, which met our guidance. Our sales continue to be led by government and enterprise customers, which is consistent with our strategy. Our international sales team recorded revenue of $6 million this quarter, a sequential increase of $1.4. International revenue accounted for 23% of Q3 revenue compared to 18.3% of Q2 revenue. Second, our gross margin decreased sequentially from 76.1% to 73.4% in Q3, which resulted in gross profit of $19.1 million. The sequential decrease in gross margin was primarily due to an increase in amortization expense associated with the intangible assets we acquired from Network Physics and to a lesser extent a decrease in gross margin or professional services. Third, our operating margin decreased sequentially from positive 0.8% to negative 0.9% in Q3. The decrease in operating margin was largely the result of expenses associated with our acquisition of Network Physics and to a lesser extent an increase in commission expense. Fourth, we generated negative $0.06 per share on a fully diluted basis. Reported earnings met our guidance range of negative $0.09 to negative $0.02. And finally, cash and marketable securities decreased $11.5 million to $81.8 million in Q3 from $93.2 million in Q2. The decrease in cash was primarily the result of paying $10 million in cash for certain assets of Network Physics in October. At the end of Q3, cash and marketable securities represented 54.7% of total assets. I will now provide additional detail regarding financial performance. First, I will focus on the following three categories of revenue, new software licenses, software license updates, technical support and services, and professional services. New software license revenue for this quarter was $10.2 million, up 6.1% sequentially and down 6.8% year-over-year. The sequential increase in license revenue resulted from an increase in revenue from corporate enterprise customers, partially offset by a decrease in revenue from US government customers and service providers. The year-over-year decrease in license revenue resulted from a decrease in revenue from the United States government customers and service providers, partially offset by an increase in revenue from corporate enterprise customers. Software license updates, technical support and services revenue for this quarter was $8.9 million, up 4.7% sequential and up 23.7% year-over-year. The sequential and year-over-year increase was primarily due to the growth of our installed customer base. Professional services revenue for this quarter, which includes both consulting and training revenue, was $6.9 million, up 0.6% sequentially and up 8.5% year-over-year. Consulting services accounts for the majority of our professional services revenue. Consulting revenue was $6.7 million for both this quarter and last quarter, and $6 million for the same quarter last year. The flat sequential consulting revenue was the result of an increase in consulting revenue from corporate enterprise customers being offset by a decrease in revenue from US government customers. The year-over-year increase in consulting revenue was a result of an increase in consulting revenue from corporate enterprise customers and US government customers driven by growth in our consulting staff from 103 at the end of Q3 of fiscal 2007 to 119 at the end of this quarter. International revenue for this quarter was $6 million, up 31.4% sequentially and up 15.4% year-over-year. International revenue as a percentage of total revenue increased to 23% for Q3 from 18.3% last quarter and 21.2% for the same quarter last year. Sequential and year-over-year increase in international revenue was largely the result of an increase in revenue from corporate enterprise customers. Our international sales strategy focuses on increasing sales to corporate enterprises and is an important element of our growth strategy. We intend to maintain our focus on increasing sales to corporate enterprises outside the United States, although we expect to continue experiencing quarterly fluctuations in international revenue. Our gross margin was 73.4% for this quarter, down sequentially from 76.1% and down from 78.9% for the same quarter last year. Sequential decrease in gross margin was largely due to $439,000 increase in amortization of intangible assets related to the purchase of certain assets of Network Physics and a decrease in gross margin from professional services. The year-over-year decrease in gross margin was largely due to a decrease in new software license revenue of $750,000 and an increase in amortization of intangible assets of $422,000. Provided the percentage of new software license revenue growth as a percentage of total revenue, we expect gross margin to increase back to approximately 8%. Operating expenses for this quarter was $21.4 million, up 13.9% sequentially and up 28.9% year-over-year. The sequential and year-over-year, increase in operating expenses, were largely the result of an increase in expenses related to the acquisitions of certain assets of Network Physics, and to a lesser extent increased commission expense. Now, for the details of operating expenses. Research and development expenses were $7.2 million or 27.6% of revenue for this quarter compared to $6.6 million or 26.5% revenue for last quarter. The increase in expense was largely due to higher compensation expenses from additional staffing related to acquisition of certain assets of Network Physics and to a lesser extent increased facility costs. Sales and marketing expenses for this quarter were $10.7 million or 41.3% of revenue compared to $9.5 million or 37.9% of revenue for last quarter. The increase was primarily due to the higher sales commissions related to increased license and maintenance bookings and to a lesser extent, higher staffing levels. General and administrative expenses for this quarter were $3.5 million or 13.5% of revenue compared to $2.7 million or 10.9% of revenue for last quarter. The increase was primarily due to $710,000 of professional services fees associated with the acquisition of certain assets of Network Physics. As a result of these factors, our operating income for this quarter was a negative $2.3 million or negative 9% of revenue compared to $211,000 or positive 0.8% of revenue for last quarter. We had operating income of $2.7 million or 11.1% of revenue for the same quarter last year. Our effective tax rate for this quarter was 9.2% compared to negative 4.4% for last quarter. The increase in our effective tax rate resulted from updating our year-to-date tax provision to reflect our revised projected fiscal 2008 book income. Net loss for this quarter was $1.3 million or negative $0.06 per share. Earnings per share were down from positive $0.06 per share last quarter and were down from positive $0.14 for the same quarter last year. Looking at our balance sheet, total DSOs at the end of this quarter were 89 days, up 7 days from the end of last quarter. Approximately 46% of total revenue for the quarter was recorded in December. The same percentage of total revenue for the second quarter was recorded in September. We expect total DSOs in the near-term to range between 70 and 80 days. In terms of forward guidance we need to consider several factors impacting our addressable markets and balance quarterly financial results with long-term strategic growth. On the negative side, first we expect our operating expenses to increase modestly while we make strategic investments to support our growth strategies. However, we are closely managing these expenses in order to align them with anticipated increases in revenue. Second, we continue to experience volatility in service provider license sales and international revenue. And finally, we anticipate modest increases in the cost of professional services as we grow our consulting business. On the positive side, first we continue to experience solid demand for our enterprise products and believe the enterprise market offers significant growth potential. Second, we continue to be encouraged by overall business activity, while our expanded application performance portfolio is opening up new growth opportunities. Third, we continue to expand our international direct sales presence and believe the international market offers significant growth potential. Fourth, we ended Q3 with record deferred revenue. Fifth, we are beginning to see improved efficiency from our sales force as a result of measures we initiated during fiscal Q2. And finally, we continue to grow our domestic direct quota carrying sales force. Consequently, we are establishing fiscal 2008 third quarter guidance for revenue of $26.5 million to $28.5 million and diluted earnings per share of negative $0.05 to positive $0.03. This concludes the financial performance review. I will now turn the call back to our Chairman and CEO, Marc Cohen.

[Marc Cohen:]

Thank you, Mel. OPNET Technologies is a leading provider of solutions for managing networks and applications. OPNET's best-in-class solutions address application performance management, capacity management and design, network operations and modeling and simulation. OPNET differentiates itself from traditional management providers by focusing on analytics. Traditional application and network management solutions focus on data collection and monitoring. These systems typically report on historical trends and the status of networks and systems. They are limited by their lack of understanding of the underlying technologies that support applications and the relationships among these technologies. While they provide useful information, they do not automate the next important step, which is analyzing collected data to transform it into actionable information. OPNET's unique analysis capabilities drive a rapid resolution and performance problems and also proactively prevent problems from occurring. These problems include, for example, network configuration errors, network congestion, poor interaction between the network and application, inefficient use of the network by application, application bugs and data base inefficiencies. Consequently, analytics can significantly improve the performance and availability of mission critical applications. We intend to drive the growth and increase profitability by executing the following strategy. First, investing in our marketing and sales. In Q3 we continued to invest in recruiting to increase the size of our sales staff. The number of quota-carrying sales staff from September 30 to December 31 increased by 6 from 92 to 98. Of these 98, 18 are inside sales representatives up from 15 in Q2. As we announced on January 9th, we also launched our Asia subsidiary based at Singapore with sales staff and consultants located in Beijing, Hong Kong, Bangalore and New Delhi. Moving forward we will provide revenue for quota-carrying sales reps, excluding sales managers and inside sales reps. We believe that this measure is a better indication of sales force productivity. Under this methodology the number of quota-carrying sales reps is 64, 58 and 58 for Q3, Q2 and Q1 respectively. The total revenue for quota-carrying sales rep in Q3 was therefore approximately $407,000 compared to approximately $431,000 in Q2 and approximately $402,000 in Q1. We plan on continuing to add new sales and inside sales staff during Q4 of FY 2008 although at a slower pace until we get back to positive net income. During our conference call on August 1st, 2007 we commented that we were taking steps to improve the performance and consistency of our sales force. We believe we are seeing the result of these efforts in the performance of our North American enterprise sales team, which achieved records in four of six regions. The team as a whole achieved over 70% of its combined sales rep quota. Looking back nine quarters, the next best was 56%. You can see this statistic illustrated on slide four of EXHIBIT 99.1 and our Q3 earnings release is available on the Investor Relations page of our web site at www.opnet.com. The second element of our strategy is selling into our diverse installed base, while continuing to add new customers. Approximately 26% of total Q3 license revenue was from new customers, compared to 10% in Q2. Third, concentrating resources specifically on developing new accounts within the corporate enterprise market because we believe that this is our largest opportunity. Our current installed based constitutes an excellent list of referenceable and active users of OPNET solution, which demonstrated potential for recurring high margin license and maintenance revenue. Approximately 31% of Q3 enterprise license revenue was from new customers compared to approximately 24% in Q2. The fourth element of our strategy is to grow sales by developing sales channels and partnerships. Over the past two years, we have dedicated significant energy and resources to our relationship with CISCO System, with which we have a worldwide distribution agreement. For a variety of reasons we've not seen the growth we had hoped for and expected. As a result, we are looking at ways of evolving this channel relationship to a more productive arrangement. In North America, we have launched our own channel program called OPNET synergy program or OSP for short. We believe that this will provide an opportunity to accelerate penetration of the mid market or direct sales force focuses on the Fortune 1000. Likewise, we are also accelerating our reseller program internationally. Overall, this strategy will provide us with a better margin, but more importantly, will allow our direct sales force to a significant amount of energy and time previously spent on CISCO and mid market account. Our direct sales force will therefore primarily concentrate on higher value direct deals. Finally, we are focused on managing our cost to increase profitability. As discussed by Mel, we are managing our cost with a goal of achieving a quarterly operating margin of between 7% to 10% by Q4 of fiscal 2009 and achieve a quarterly operating margin of between 15% to 19% by Q4 of fiscal 2010. I will now provide some highlights. OPNET software solutions, parallel our four markets for corporate enterprises, government and defense agencies, service providers and network equipment manufacturers. Our software is used in planning, engineering and operations for the following, real time monitoring of application network and systems performance, pin pointing the root cause of application performance problems, detecting operational configuration problems that degrade performance, auditing compliance of network security policies, preventing mistakes in operational changes, planning for traffic growth and infrastructure investments, preparing for network failures and accelerating the delivery of new network technologies. Corporate enterprises are a growing market and primarily purchase IT Guru, Network Planner, ACE, ACE Live, IT Sentinel, Panorama, SLA Commander, and associated modules. The diversity of the enterprise accounts we sold to in Q3 highlights the size of this addressable market. We closed deals with corporate enterprise, including Abbott Labs, AIG, Banner Health, BASS, BB&T, B&P Paribas, Boeing Australia, BWI Germany, Charles Schwab, Citigroup, Coty US, Cummins Engine, New company, Delta Technologies, Dow Jones, EDS or the French National Electric Company, Embark, Ford Motor Company, IBM Global Services, Info USA, ING Investment Management, Lehigh Valley Hospital, Lukoil, Medtronic, Motorola, Navy Federal Credit Union, NBC Universal, Oracle Corporation, Pacific Gas & Electric, Pepsi Business Solutions, [Huro] Systems, Pfizer, Scottish and Southern Energy, Sisters of Mercy Health System, Sunlife Financial, Target, Warner Brothers, Williams Information Technology and Wyatt Pharmaceuticals. In Q3, we also renewed a significant outsourcing deal, focused on our Sentinel solution for a major global financial institution. All we are providing, software, hardware and services, due to the nature of this transaction, it is being recognized as only services. We also closed our largest Panorama deal to a corporate enterprise account. Government and defense agencies purchase our full range of software products. Revenue from US government clients was 34% of Q3 revenue, down from 47% in Q2, and down from 40% of Q3 revenue in the prior fiscal year. Sequential decrease in revenue from US government clients was expected during the fiscal Q3, and we typically see an increase in revenue from US government clients during fiscal Q2 as a result of their September 30th fiscal year end. It is important to note, this course of revenue originates from many different agencies programs and contractors. In Q3, we closed deals with domestic and international government and defense agencies, including the Department of Homeland Security, the FBI, La Poste or the French Post Office, the US Department of Agriculture, the US Missile Defense Agency National Team, the Northern Ireland Office, and the US Air Force. Among these transactions was a one year renewable site license focused on our Panorama solution for real-time systems monitoring. In addition we closed deals with integrators and contractors supporting our government and defense clients, including Aerospace Corporation, BAE Systems, Boeing, Booz Allen & Hamilton, Cap Gemini, L3 Communications, Lockheed Martin, Raytheon, Shared Spectrum Company and Sparta. Service providers purchase our entire portfolio of products depending on the specific application. Our network service provider clients continue to have tight budgets and extended sales cycles. Revenue from service providers continues to be lumpy and we are down in Q3 relative to Q2. In Q3 we closed deals with service providers including AT&T, British Telecom Laboratories, Clara, America Movil, French Telecom, Korea Telecom, Qwest, Sprint-Nextel, Swisscom, Telefonica and Telus. Among these transactions was a one year site license, the global service provider that contributed $1.7 million to deferred license revenue. The site license focused -- focuses on our Sentinel Solution rotating routers, switches and firewalls as well as in our NETCOP solution for providing real-time situational awareness of topology, traffic and alert data. Network equipment manufacturers primarily purchase Modeler and Transport Planner. Revenue from NEMs in Q3 was up relative to Q2. In Q3 we closed deals with NEMs including Canon, Honeywell, Huawei Technologies, Lucent Technologies, Mitsubishi Electric and EC Corporation, NTT DoCoMo, Samsung, Hallux, (inaudible) Technologies and Sico Electronics. On a competitive line we continue to primarily see in house ornate solutions except in enterprise accounts, where some of our solutions encounter the following competitors. Compuware, CA, Netcop Systems and Quest Software. IT Guru Systems Planner now sold by CA competes primarily with BMC. Overall we have experienced few competitive losses this quarter. To summarize, we're continuing to execute on our vision, a vision based on the concept that analytics driven by intelligent software, software that understands how networks, applications and systems operate, provides significant new value to a large diverse customer base including corporate enterprises, government and defense agencies, network service providers and network equipment manufacturers. Our software is unique in its ability to analyze the communication networks, applications and systems in order to identify, solve and prevent critical problems that our customers are facing every day. Our software represents a paradigm shift from the past. We are excited about the opportunity in front of us to deliver value and return on investment to many thousands of customers worldwide. To recap, fiscal Q3 was a record quarter for OPNET. We achieved a record $26 million in revenue. We achieved international revenue of $6 million up $1.4 million from Q2. We ended the quarter with record deferred revenue of $26.5 million. We delivered record sales and strong across the board performance in our North American corporate enterprise business. We began to see the benefits of our emphasis on [multi-quarter] pipeline generation and forecasting. We rapidly generated -- integrated into our business a new appliance based monitoring solution that was accelerated by the acquisition of certain assets of Network Physics in October and generated revenue during Q3. We launched the OPNET synergy program to address the mid market and refocus our sales team on direct business. We generated negative $0.06 in EPS, which included acquisition costs of $710,000 associated with our acquisition of certain assets in October. Before we conclude, I'd like to note that Jack Jarman, VP of North American Sales separated from the company in early December. He was appointed VP of North American Sales in April of 2007. We are in the process of searching for replacement. We thank you for your time and will now take your questions.

[Operator:]

(Operator Instructions) Our first question is from the line of Gary Spivak with the Stanford Group. Please proceed with your question.

[Marc Cohen:]

Hey, Gary.

[Gary Spivak:]

Good evening gentlemen. A couple of questions, one is post the acquisition did you see any change in the competitive landscape, anybody new showing up or anybody showing up more or less frequently than it had in the past?

[Marc Cohen:]

Absolutely, as a result of the acquisition we are now competing with another group of companies including [Netconn], which I mentioned in the call that they have a number of products in the real-time monitoring space, which is the market that we are now addressing with our ACE Live appliance. And there are a number of other players in that space.

[Gary Spivak:]

Okay. Second, you put out some margin goals for Q4 this year in '09 and 2010. Do you have specific actions, is that generally based on your license growth expectations or there are some cost synergies that you are looking to put into the model?

[Mel Wesley:]

Hey Gary, it’s Mel. We do have certain growth projections for all the different line item of revenue and cost as you would expect and we have currently put in place initiatives to pursue those.

[Gary Spivak:]

Okay. And finally, just a macro question

[Mel Wesley:]

So far, we haven’t seen anything that raises any concerns. We're seeing tremendous amounts of activity, both on the general tryouts that are being requested and so I can't say that we've seen delays yet in the budget process. So it's probably a little too early to tell.

[Gary Spivak:]

Okay. Thank you. I will finish here.

[Mel Wesley:]

Thank you. Thanks, Gary.

[Operator:]

Next question is from the line of Richard Sherman with MKM Partners. Please proceed with your question.

[Richard Sherman:]

Hey, good afternoon guys. Can you hear me?

[Marc Cohen:]

Hey, Rich.

[Richard Sherman:]

Thanks. I have a couple of questions here. In terms of the operating margin guidance that you provide

[Mel Wesley:]

Good question. That’s a GAAP.

[Richard Sherman:]

The GAAP number?

[Mel Wesley:]

GAAP number, correct.

[Richard Sherman:]

All right. Great! And then in terms of the guidance that you are providing

[Marc Cohen:]

March '08? We have 16.8% modeled.

[Richard Sherman:]

Okay. Great! And then, I guess Marc, you had mentioned that Jacques Jarman had left in early December

[Marc Cohen:]

Well

[Richard Sherman:]

Okay. All right, well thank you.

[Marc Cohen:]

Thanks.

[Operator:]

Our next question is from the line of [Loren Therese] with [Towhead Asset Management]

[Loren Therese:]

Good evening, I had a question on the share buyback. Can you let me know how many shares you bought back under the old plan? And

[Mel Wesley:]

Sure. This is Mel. Last quarter we repurchased 200,000 shares at average price of $8.90 and inception to date we have repurchased 952,000 since inception of that plan that was started back in January of 2005 and the average price of the purchase is $9.94 for total amount of $9.6 million.

[Loren Therese:]

Okay, great. And also I have another question on Network Physics. I know you bought certain assets, obviously the technology

[Mel Wesley:]

Sure. We did not acquire any facilities or any facility lease obligations. We did acquire 25 employees, a little over of half of which were related to research and development staff.

[Loren Therese:]

And

[Mel Wesley:]

It is part of the reason why we had a sequential increase and yes, we do plan on keeping these individuals.

[Alain Cohen:]

Not all of the individuals, not all the 25 were in R&D, some were in sales related functions that which we are expanding anyway, as you know, based on our plans. Continue to grow our sales and marketing activity. So, that fits directly into our plans and then a certain number of those 25 people were also, were in R&D and of course, we are going to bring new products. It's a solution called ACE Live has a very promising future and so, we are continuing to invest in the R&D there. So, as an outset we are in general controlling our expenses on the R&D side, but this is one particular area in which we are investing quite a bit because of the tremendous promise that this solution holds. About the facility, just trying to clarity that, even though we didn't acquire a lease obligation during that acquisition, regarding the acquisition of asset of essentially all the assets, we do have, we have established a facility for the people, who are located in the Silicon Valley area from Network Physics. So, we do have a new facility as a result of this activity.

[Loren Therese:]

Okay. Great, one last quick question

[Mel Wesley:]

Nothing material now.

[Loren Therese:]

Okay, great. Thank you very much.

[Marc Cohen:]

One second, this is Marc. I just want to a one quick follow-up to what Rich was saying and just to add that in the interim, I am going to be serving as acting VP of North American sales. We can move on to the next question.

[Operator:]

Thank you. Our next question comes from the line of Kim Caughey with Fort Pitt Capital. Please proceed with your question.

[Kim Caughey:]

Hi, I heard Mr. [Mulcite] asking here and

[Marc Cohen:]

So

[Kim Caughey:]

Okay. Well part of it sounds really good, especially, you know, decreasing Cisco inter-phasing, as you are not getting the words out of it. But in your in-house sales staff

[Marc Cohen:]

It's a great question. So with the Network Physics acquisition that we did -- it was the Network, that did work with Network Physics network to channels partners and we are now working directly with them, so it was a jump start to our channel program and we do have [facts] we have a VP of Channel alliances who has a fair amount of experience from Hewlett-Packard working on the channel side. We have also retained a consultant who has a lot of channel experience to really accelerate the build out. So it's something we are definitely putting a lot of senior staff and energy on.

[Kim Caughey:]

Well, how long do you think… how long does your plan say until you begin to see material results from this channel build out?

[Marc Cohen:]

We will see it is pretty quick and by, just to give you an example

[Kim Caughey:]

Okay, great. Thanks.

[Operator:]

Our next question is from the line of [Glenn Nathan with GTK Capital]. Please proceed with your question.

[Glenn Nathan:]

Good afternoon, gentlemen.

[Marc Cohen:]

Good afternoon.

[Glenn Nathan:]

In looking at your model, since you are not reducing sales force and actually adding to the sales force, since you are not reducing research and development expenses, I guess this implies that you are going to have a significant increase in sales.

[Marc Cohen:]

A bit.

[Glenn Nathan:]

Did I read that correctly?

[Mel Wesley:]

Well, yes, I will address that. This is Mel. Hi, Glen, how are you doing?

[Glenn Nathan:]

Good. Thanks.

[Mel Wesley:]

In terms of our license revenue growth that we have embedded in the model for the one year horizon and going to your, I guess I should specify about Q4 of next fiscal year we have a growth rate on license up 20%, year-over-year in there and updates in [Texo Corp], we have also a growth of 20% year-over-year, contemplated.

[Glenn Nathan:]

That's terrific, if you can do it. I mean

[Marc Cohen:]

Well, Glenn, it's actually both. If you look back at our trend for year-over-year growth in those license and update in tech support revenue. Take license for instance, if you back 10 quarters and average our year-over-year growth rate, it is about 17% and if you average our update in tech support growth rate it is about 20%. So those are very close to what we have historically seen, obviously recently we have had some decrease, but if you go back 10 quarters you will see that those growth rates are definitely achievable, based on what we have done in the past.

[Glenn Nathan:]

Okay, great. Is there much pricing pressure from competitors or customers?

[Mel Wesley:]

No, we are not seeing any pricing pressure at this point.

[Glenn Nathan:]

And my last question is

[Mel Wesley:]

No, I didn’t mention, because it is they are a channel partner for our systems, planning and mainframe planning solutions, but it is still in its early stages and moving slowly at this point.

[Glenn Nathan:]

Okay. Okay, thank you very much and good luck.

[Mel Wesley:]

Thank you.

[Operator:]

(Operator Instructions) Our next question is from [Jeffery Myers], Wachovia Capital. Please proceed with your question, sir.

[Jeffery Myers:]

Great, thanks guys. A few questions

[Marc Cohen:]

Well, unfortunately we are not going to break that out, because we don't break out price revenues, but it did contribute to revenue in the quarter.

[Jeffery Myers:]

Got you. Okay. Next question is

[Marc Cohen:]

It was.

[Jeffery Myers:]

So

[Marc Cohen:]

Well, one big item was the result of a payment that was due from CISCO that we did not receive. It was just under $1 million. So that significantly contributed to the increase. We did get that payment in shortly after December 31st.

[Jeffery Myers:]

I got you.

[Mel Wesley:]

But we fully expect DSO's to go back down to the 70 to 80 range.

[Jeffery Myers:]

Got you, okay. And then in terms of the deferred revenue increase quarter-over-quarter that was obviously pretty impressive

[Mel Wesley:]

We don’t typically breakout the conferment to that, but Marc did mention that 1.7 of the deferred revenue increase was related to a service provider sales. So, obviously there was a significant piece of that was, there was license, but license and maintenance both contributed to the sequential increase significantly.

[Jeffery Myers:]

Okay. Is this the right way to think, you guys had I guess like $4 million or so increase in deferred, if you add that to your revenue that comes out about 30 million. Is that how you look at your bookings? Or

[Mel Wesley:]

Well, that’s a good way to think about it. The strong sequential increase we had in deferred certainly that was evidenced by the strong sales execution we had in the quarter and certainly that would be revenue downstream, but, unfortunately, due to certain accounting guidelines, we have to differ some of that and some of its basically attributable to PCS, which is right way recognized over 12 month period typically. So

[Jeffery Myers:]

Right.

[Marc Cohen:]

As well as the -- this is Marc, as well as the other site license that I referred to on the government side that points into deferred too, because that will be recognized gradually.

[Jeffery Myers:]

Right. Is does that mean, would you say

[Mel Wesley:]

Well, in total it was not, but in license and maintenance it absolutely was.

[Jeffery Myers:]

Got you. And the last question is house keeping. Could you break out the stock comp in amortizations for line items?

[Mel Wesley:]

Yes, I can. You are talking about line items on the financials?

[Jeffery Myers:]

Yeah.

[Mel Wesley:]

So you want some additional details that's not included in the GAAP to non-GAAP reconciliation?

[Jeffery Myers:]

Right, like R&D, sales & marketing, D&A.

[Mel Wesley:]

Yeah, I'll have to get back to you on that. We just, we have to be real careful with the non-GAAP disclosure.

[Jeffery Myers:]

Got you.

[Mel Wesley:]

Well, we also do some commission from that.

[Jeffery Myers:]

Okay. All right, guys, thanks.

[Mel Wesley:]

Thank you.

[Operator:]

Our next question comes from the line of Bill Gildea. Please proceed with your question.

[Mel Wesley:]

Hi Bill.

[Bill Gildea:]

You talked about the deferred because it seems to, [ad finance], well I have I will ask about the government fees, which obviously was off to another strong September?

[Mel Wesley:]

Right

[Bill Gildea:]

Any concerns around and I realize you are trying to go prime more and more and it have been successful, but

[Mel Wesley:]

No concern there, the government yields we've had tend to pretty lumpy and we are hitting and winning larger and larger contracts, which means that the sales cycle o those tend to be somewhat prolonged. Your point about missing prime is accurate, we are applying on more contacts, but as you know in this business you are trying with someone you and your team next time and the next time you are competing with them, that's pretty much how that this business works. So we really don't see any concerns there.

[Bill Gildea:]

The guidance in terms of the sequential increase into the March quarter

[Marc Cohen:]

It's not driven by government, but we don't expect any negative, we would accept our typical results from government fourth quarter, this quarter.

[Bill Gildea:]

Okay, good. And then just lastly, in terms of, you been obviously, the ER exposed to very large financial institutions. He did call them out as revenue customers during the quarter. What was your earlier comment that you thought it sure as hell if you had seen impact there assuming macro gets quarter strap a year kind of thing?

[Marc Cohen:]

Well, there is no doubt that some of our financial customers, for one of which, by the way that was very impacted by the recent crisis had a sizeable purchase with us, because they see what we do as a key part of their operation. So they did move forward with it but there is no doubt that with that customer and with other customers in the same situation. There is a lot of scrutiny being placed on [consensus] and there was a lot things being put on hold. So I would expect that that factor overall will be a little soft for a while. But we definitely are continuing to selling through it and as you saw from the list of the names that we are going through. We have an extremely broad base of companies and verticals that we sell into so, I don't see that as having an overall important significant impact on OPNET.

[Bill Gildea:]

Okay. Let me just one more. If you think about it again, the March quarter, range there. Are you assuming that you have both of those site licenses that service provider like government Fed license convert in the March quarter?

[Marc Cohen:]

Yeah. We have, we have that contemplated in the guidance, but we are not disclosing to what degree.

[Bill Gildea:]

And

[Mel Wesley:]

It was -- the deal was approximately $0.5 million.

[Marc Cohen:]

But let me keep in mind that when you, I did emphasize in the call that these are one-year licenses. And as a result of that, at best those would be recognized rabidly.

[Bill Gildea:]

Very good, that's helpful. Thank you.

[Marc Cohen:]

Thanks, Bill.

[Operator:]

Our next question is from Richard Sherman with MKM Partners

[Richard Sherman:]

Hi, Mel. I just had a clean-up question as of wrapping up the fiscal year here. Do you have the stock comp, amortization, adjustment and income tax adjustments for pro forma for the June 2007 quarter?

[Mel Wesley:]

That we did not post. And we have to disclose that obviously in the PR before we are going to discuss that. So I will have to get back to you on that.

[Richard Sherman:]

Okay.

[Mel Wesley:]

Now, just to know, you can't get that information from the Q unfortunately, I know you have to dig through there, but that information is broken out and available on the Q for that quarter.

[Richard Sherman:]

Okay.

[Mel Wesley:]

But since we hadn't disclosed it in the reconciliation unfortunately I can't discuss it at this time.

[Richard Sherman:]

Okay and then just maybe a question on the gross margin line, as the ACE appliance starts to ramp up and it has a hardware component. Is that cost going to be recognized under your cost of software licenses? And

[Marc Cohen:]

Yes, you are correct, Richard. It is going to be recognized in the cost of revenues for new software licenses and that cost is contemplated in the operating income guidance that we gave for Q4 fiscal '09 and Q4 of fiscal 2010. And yes, and it does, it obviously will have a little bit of an impact. But the margins there are 80% costs on their sale so, it's not a kind of huge issue, but it does way a little bit more heavily than say like a regular license sale order because those are generating margins of about 97% to 98%.

[Richard Sherman:]

Okay. Great! And then maybe just one last question. As you ramping up the reseller channel

[Marc Cohen:]

I am sorry, what $10.7 million were you referring to. I apologize.

[Richard Sherman:]

This is sales and marketing expense, as you are trying to use VARs, with a certain amount of care and feeding and nurturing that needs to be done. Have you largely seen in the channel now? Or

[Marc Cohen:]

As I mentioned earlier, a lot of those channel partners are already trained with some of the solutions we have, particular the ACE Live solution. And we believe that training them on the other products in particular, the ACE Plus solution will be very quick and we've already started that process. So, I don't expect that training them will be a complex process or take long. We are also not going to take the entire portfolio of solutions and dump it in there last. We're going to specifically focus them on the application performance management solution.

[Richard Sherman:]

Great! Thank you, Marc.

[Marc Cohen:]

Thanks.

[Operator:]

Our next question is from the line of Peter Wright with P.A.W. Partners. Please proceed with your question.

[Peter Wright:]

Hi, a couple of questions. One, could you flush out a little bit about your March '09 and March 2010 concept of 7% to 10% operating margin. I think on a question before you said that there would be GAAP operating margin and I guess the question I would have is what kind of revenue and gross margin assumption do you have to get to in order to accomplish that objective?

[Mel Wesley:]

Sure. Hey Peter, it's Mel, how are you doing?

[Peter Wright:]

Hi.

[Mel Wesley:]

Well as I mentioned before in terms of the revenue assumptions on license revenue and updates on tech support revenue we had a 20% year-over-year growth factored in and for I'll just reference at this time the Q4 fiscal '09 model, for professional services we have a 3.2% growth model and we have obviously, as you can see in the model direct cost and we have modeled in at approximately 22% of total revenue. In terms of R&D we have a growth of 5% year-over-year.

[Peter Wright:]

When you say

[Mel Wesley:]

That's right. 74% gross margin.

[Peter Wright:]

74, I thought you said 23% direct cost.

[Mel Wesley:]

Correct, 23% direct cost and then 74% gross margin.

[Marc Cohen:]

Okay. And then R&D will grow year-over-year from our Q4 projected base of 5% and then our cost target for sales and marketing is by next quarter, by Q4 of fiscal '09 will have cost for sales and marketing of 36% of total revenue. And if you look back at fiscal 2007, 2006, 2005 and 2004 we were between 34% and 36% in terms of our sales and marketing cost to total revenues. So it is certainly a achievable number there. And then our G&A growth assumption is 5%.

[Peter Wright:]

Okay. I am sorry, little slow. Your gross margin of 74, SG&A is 36, is that, sales and marketing of 36, R&D of – I presume is it 23, did you say?

[Mel Wesley:]

Well, the range is, it is 24 to 25.

[Peter Wright:]

R&D, 24 to 25. And G&A?

[Mel Wesley:]

G&A is 9%, 10% and that contemplates the 5% year-over-year cost increase.

[Peter Wright:]

Okay. Right. If R&D is 24 to 25 and sales and marketing is 36, that’s 60, G&A is 10, that’s 70. And the gross margin is 74 actually. Gross margin is going to be 77, right?

[Mel Wesley:]

Yeah. 77, I apologize.

[Peter Wright:]

Great! Okay.

[Mel Wesley:]

23% direct cost, 77% gross margin.

[Peter Wright:]

Yeah. Okay. Fine. So basically, you are assuming 20% license growth to 20% overall revenue growth?

[Mel Wesley:]

20% license growth, 20% updated in fact the before growth and 3.2% professional services growth.

[Peter Wright:]

And, the concept to get there for fiscal '10 is that consistent on the top line and then just holding the growth revenue. What changes did go from 7 to 10 base, 15 to 19?

[Mel Wesley:]

Sure. When we go from the Q4'09 model or the Q4 '10 model, we have the license revenue growing 25%, updated tech support revenue growing 27.5% and that’s to reflect the increase of license revenue and then professional services revenue growing at 10% and that’s to contemplate the additional services that will come out of the license sales.

[Peter Wright:]

And

[Mel Wesley:]

On the expense side we have R&D of growing 7.5% from Q4 fiscal '09 to Q4 fiscal (inaudible).

[Peter Wright:]

[About a half] percentage drops 2 or 3 points, 21 to 22 that point.

[Mel Wesley:]

Correct.

[Peter Wright:]

Okay.

[Mel Wesley:]

Correct.

[Peter Wright:]

And

[Mel Wesley:]

It does, it goes up to 80%.

[Peter Wright:]

Okay. And sales and marketing

[Mel Wesley:]

It actually drops down to between 33% and 34%.

[Peter Wright:]

And G&A?

[Mel Wesley:]

Is 9% to 10%.

[Peter Wright:]

That's 9 to 10. Let's say 54 and 64. Okay, that works. Second question.

[Mel Wesley:]

Actually before you do that I will comment that this information is posted.

[Peter Wright:]

Okay.

[Mel Wesley:]

You can get it off our website.

[Peter Wright:]

Okay.

[Marc Cohen:]

Yes, the growth rates are not posted. But certainly the model is, Peter, so.

[Peter Wright:]

Got you. And then the second question is on

[Marc Cohen:]

I am sorry.

[Peter Wright:]

This was the first quarter you had in Network Physics, correct?

[Marc Cohen:]

That's correct.

[Peter Wright:]

And could you give me a concept

[Marc Cohen:]

Yeah, we are not going to break that out separately. We really can't, because we don't track the business by product and the employees that we acquired from Network Physics are working on various products, not just ACE Live. So.

[Peter Wright:]

Well, how much added expense those 25 employees question?

[Marc Cohen:]

Approximately $1 million a quarter in salary and benefit.

[Peter Wright:]

Okay. And I guess the second question is

[Marc Cohen:]

There was.

[Peter Wright:]

And could you at least characterize it for a $0.5 million or $1 million is that a reasonable characterization?

[Marc Cohen:]

I can't break that out. We do not breakout the product revenues.

[Alain Cohen:]

The only thing we will say is that we are pleased with it, but we're not going to give any specifics.

[Peter Wright:]

Okay. So, addition by subtraction would it be fair to say that fundamentally your business was effectively flat in software licenses if you were to take up the impact of Network Physics which was about the same as what happened in the previous fiscal year?

[Mel Wesley:]

Are you talking to sales or revenue?

[Peter Wright:]

No, license, actually its reported license. It sounds that, but I guess the point that you are making is while that is true that reported revenues were somewhat flat sequentially flat. You really, your orders were significantly greater because of your competitive one year subscription of licenses that are on the balance sheet?

[Marc Cohen:]

Our sales generation in Q3 compared to Q2 far exceeded the contribution that ACE Live provided.

[Peter Wright:]

And I guess the final question, thank you. And the final question would be

[Marc Cohen:]

Sure, absolutely that's what -- we are going to find someone that will continue to grow the revenue as we expect. So, right now as I mentioned, I am passing in that role and we have a very qualified group of sales managers that report directly to me.

[Peter Wright:]

And so you basically are -- are you suggesting that you think you can go through this transition without a beat at least for the next couple of quarters?

[Marc Cohen:]

Yes, that's what I am saying.

[Peter Wright:]

Great, thank you.

[Mel Wesley:]

Thanks Peter.

[Operator:]

Ladies and gentlemen there are no further questions at this time. I would like to turn the floor back over to management for closing comments.

[Marc Cohen:]

Great. I'd like to thank everyone for attending today. The conference call is now closed.

[Operator:]

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time.