Network Equipment Technologies, Inc. Q4 2008 Earnings Call Transcript

Network Equipment Technologies, Inc. (NWK)

Q4 2008 Earnings Call Transcript

April 30, 2008 4:30 pm ET

Executives

Leigh Salvo – IR

John McGrath – VP and CFO

Nick Keating – President and CEO

Analysts

Anton Wahlman – ThinkEquity Partners

Greg Mesniaeff – Needham & Co.

Eric Buck – Brean Murray

Marc Abizaid – Mohican Financial

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the Q4 2008 Network Equipment Technologies earnings conference call. My name is Robin and I'll be your coordinator for today. At this time all participants are in a listen-only mode and we will be conducting a question-and-answer session towards the end of this conference. (Operator instructions) I would now like to turn the call over to your host for today, Miss Leigh Salvo. Please proceed, ma'am.

Leigh Salvo

Welcome everyone to our call this afternoon during which we will discuss results for Network Equipment Technologies fourth fiscal quarter of 2008. With me today are Nick Keating, President and CEO; and John McGrath, CFO.

In keeping with the Safe Harbor provisions of the Private Securities Litigation Reform Act, I want to remind everyone that we will be making some forward-looking statements and projections today including those relating to future revenue, operating results, and financial conditions. Investors are cautioned that these statements are based on current estimates and assumptions that involve risks and uncertainties that might cause actual results to differ materially from those expressed or implied in the forward-looking statements. These risks and uncertainties include market acceptance for our new products, timely completion of product development initiatives, new competition and technological changes, the successful integration of Quintum's operations, success in building new sales channels, circumstances regarding specific sales that can affect the recognition of revenue, effective completion of the transition of contract manufacturers, and other risks, including those identified in the company's filings with the SEC, including Form 10-K and 10-Q and in other press releases and communications. The company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. Additionally, an audio archive of this call will be available on the company's web site for at least 12 months. The statements made on this conference call are only made as of April 30, 2008, and we disclaim any duty or intention to update forward-looking statements.

In addition to financial measures presented in accordance with GAAP we will also be discussing certain non-GAAP financial measures that are adjusted from results based on GAAP to include certain expenses, gains and losses. These non-GAAP measures should not considered a substitute for, or superior to, GAAP results. Please refer to the press release issued today for further detail regarding the non-GAAP measures. Reconciliation to the GAAP can be found in the press release which is posted on our web site.

Our agenda today begins with NET's CFO, John McGrath, who will provide a detailed review of our financial results. Nick Keating, CEO, will then comment on the quarter's financial and operational highlights. John will then offer financial guidance for the remainder of this fiscal year, and we will open the call for your questions.

At this time I would like to turn the call over to John McGrath.

John McGrath

Thank you, Leigh. In the press release issued today and available on our web site, we reported that total revenue for the fourth quarter of fiscal '08 was up 15% from the prior quarter and up 34% from the fourth quarter of fiscal '07. For the entire fiscal year, revenue was up 38% to $116.1 million, which includes approximately four months of Quintum revenue.

Product revenue was up 18% sequentially to $30.2 million, a 41% increase from the same period last year. Product revenue from our government business increased 16% from Q3 to $24.6 million. This compares to $20.6 million for Q4 a year ago. Product revenue from our enterprise business increased 29% to $5.6 million and was up more than sevenfold from Q4 of the prior year.

Service and other revenue of $3.2 million was 10% of total revenue, down $311,000 sequentially and down $440,000 from the fourth quarter last year. The decrease is due to the timing of service projects.

Gross margin in Q4 as a percentage of revenue was 48.3%, down from 49.3% in Q3. Gross margin was 55.4% for Q4 last year. Product margin in Q4 as a percentage of revenue was 53.8%, down slightly from 54.2% in Q3. Product gross margin was 61.9% for Q4 last year. Product gross margin in Q4 '08 was negatively impacted by transition costs of roughly $1 million related to our move to a new contract manufacturer, which are expected to significantly decrease going forward. Further, we incurred $281,000 for a one-time non-cash charge related to recognizing the write-up in basis of Quintum finished goods inventory as part of the purchase accounting for the acquisition. Also impacting product margins in Q4 '08 was approximately $330,000 related to the amortization of intangibles acquired from Quintum, which is expected to be ongoing. Product margin in Q4 '07 was positively affected by the final retention payment received from NATO of $1.2 million which had 100% margin.

Service and other margin in Q4 decreased to a negative 3.3% from 14.2% in the prior quarter and 18% in the fourth quarter of the prior year. Service margin was negatively impacted by decreased service revenues as most of service costs are fixed.

Included in cost of sales was stock compensation of $125,000 in Q4 '08, compared to $88,000 in Q3 '08 and $41,000 in Q4 '07. Fourth quarter operating expenses were $15.6 million, up $1.9 million sequentially, and down $8.8 million from the same quarter last year. Total company headcount was down slightly to 308 employees at the end of Q4, a decrease of two from the end of the prior quarter, and an increase of 70 from Q4 last year. This was primarily the result of the acquisition of Quintum in December 2007.

During the fourth quarter of fiscal '08 expenses attributable to the acquisition of Quintum were approximately $2.9 million, including $555,000 of operating expense related amortization of acquired intangible assets. The Quintum acquisition occurred near the end of Q3 so these expenses were only $694,000 in Q3 '08, including $46,000 of amortization of intangible assets. Also affecting operating expense in Q4 compared to Q3 was increased (inaudible) costs of approximately $0.5 million. In our fiscal Q3, which is the last quarter of the calendar year, we typically see reduced expenses related to FICA and 401(k) plan match as many employees reach their maximum before the end of the calendar year begin again in the new calendar year. The amount was partially offset by a decrease in incentive compensation of $85,000.

At the end of the fourth quarter of fiscal '07 we also vacated our former manufacturing building on our Fremont campus part of which was subsequently subleased. As the company does not intend to use the building during the remaining term of lease we incurred a charge of $10.2 million in the fourth quarter of fiscal '07. A large portion of this charge relating to the write-off of leasehold improvements was non-cash. The write-off eliminated expenses of approximately $850,000 per quarter.

Sales and marketing expense was $5.9 million in Q4, up $823,000 compared to the prior quarter, and up $928,000 from the fourth quarter a year ago. The sequential and year-over-year increases were largely due to the acquisition of Quintum. The sequential increase was partially offset by a decrease in sales commissions of $187,000.

R&D expense was $6.5 million in Q4 '08, up $745,000 from the prior quarter, and up $843,000 from the fourth quarter a year ago. The increases are related to the addition of Quintum and to fringe benefits and were partially offset by a deferral of $125,000 of cost related to a funded R&D program. Those costs are deferred until we recognize revenue related to the program, which is expected later in fiscal '09.

G&A expense was $3.1 million in Q4, up $299,000 compared to the prior quarter, and down $501,000 compared to the fourth quarter a year ago. The sequential increase in G&A costs is related to Quintum and fringe benefits, but was offset by a decrease in legal fees of $123,000. The decrease in G&A compared to last year's Q4 is primarily due to a charge in Q4 '07 for rent-related expenses for our idle manufacturing facilities. Included in operating expenses for Q4 '08 are charges related to stock compensation expense of $852,000, compared to $681,000 in Q3, and $327,000 in Q4 last year.

Other income in the fourth quarter of fiscal '08 was $157,000, compared to $254,000 for Q3 '08, and $19,000 in Q4 of the prior year. The increase over the prior year was due mainly to translation gains of which a significant amount was related to the closure of a European subsidiary.

Net interest income for Q4 '08 was $165,000, compared to $676,000 in the prior quarter and $526,000 in Q4 of the prior year. The interest earned from the proceeds of our new convertible debt was offset by the additional interest expense. As such the decrease in net interest income related to lower yields on investments and the use of $24 million related to the Quintum acquisition.

The fourth quarter of fiscal '08 had a tax benefit of $2 million as compared to a tax provision of $47,000 in the prior quarter, and a tax benefit of $513,000 in the fourth quarter a year ago. The benefit in Q4 of fiscal '08 related to the reversal of the reserve for deferred tax assets for the United Kingdom as they have begun to earn profits and realize NOLs. The benefit in Q4 of last year related to the completion of the inspection period for an international subsidiary and expiration of a tax liability to the state of California.

Turning to net income, the company reported net income of $2.8 million for Q4 '08, or $0.09 per share compared to net income of $1.5 million, or $0.05 per share in the prior quarter, and a net loss of $9.5 million, or $0.37 per share in the fourth quarter fiscal '07. Included in net loss for Q4 '07 was restructure cost of $10.2 million.

On a non-GAAP basis, net income was $2.6 million in Q4 '08, compared to $2.6 million in Q3 '08, and $1.1 million in Q4 '07. Non-GAAP income adjusts for non-cash compensation, amortization of acquired intangibles, restructure charges, and other significant non-recurring items.

Cash balances at the end of Q4 '08 were $165.7 million, up $4.5 million from $161.2 million at the end of Q3. Cash and investments increased by $75.5 million from the prior year. In fiscal '08, we received net proceeds of $82 million related to our convertible debt offering, and used approximately $24 million for the acquisition of Quintum.

During Q4 '08, our Board of Directors approved a stock buyback of up to $20 million based upon market conditions. As the company is committed to a long-term growth and acquisition strategy, the company will balance its cash needs with its buyback strategy. It should be noted that the company will not buy back stock when the company stock window is closed. As such no stock has been repurchased to date.

Accounts receivable were $23.2 million, up $2.8 million from Q3 '08, and up $8.4 million year-over-year. The increase in accounts receivable is primarily due to (inaudible) DSOs at 63 days increased four days sequentially and increased nine days year-over-year. Our target DSOs remain between 60 and 70 days. Net inventory was $10 million in the fourth quarter and represented a decrease of approximately $2.9 million as compared to the prior quarter as we continue to draw down on inventory that was built [ph] prior to the transition to a new contract manufacturer. Net inventory decreased $466,000 compared to the same quarter a year ago.

Now I'd like to turn the discussion over to Nick Keating, our CEO.

Nick Keating

Thank you, John. Overall, fiscal year 2008 was a significant year for NET. We grew our revenue 38%, we reached the highest level of profitability in ten years, and our cash position increased by more than $75 million. The plan we laid out for fiscal year 2008 included the expansion of our product portfolio and a global reach through internal development and acquisition. We were successful on both fronts. We identified three growth markets for our products and while it still early for some of these sectors we are well positioned to capture market share as they emerge. Today, these markets include the VoIP equipment market, the multi-service access market, and the high performance computing and networking market. I would like to take a few minutes to discuss our progress in each of these markets.

For the VoIP equipment market we offer a broad range of VoIP switches and gateway solutions for enterprise and government customers. Our solutions support enterprise applications, including VoIP networking, unified communications, enterprise mobility, and SIP trunking. NET also offers advanced secure VoIP solutions for applications where secure voice networking is critical. Our VoIP products are being used by customers and in trials in more than 60 countries worldwide enabling a number of applications in key market segments. We have defined these segments as unified communications, VoIP networking, enterprise mobility, SIP trunking, and secure voice. Throughout the year we gained traction in each of these segments.

Starting with the unified communications segment, partnerships with systems integrators are a key component of our UC strategy as the worldwide rollout continues. In fiscal year 2008 we attained Gold Certified Partner Status in the Microsoft Partner Program with a Competency in Information Workers Solutions. In addition, we are certified for open interoperability by Microsoft and became a member of the HP Developer and Solution Partner program.

In addition to these partner relationships and certifications, we are actively engaged with other systems integrators not yet announced. Our strategy enables us to work with the best of breed applications to provide users with a coherent and consistent experience. Working with our partners, we have had successful installation at a German consultancy firm, a leading French hospital and medical university, a Belgium based publisher, and one of New Zealand's foremost universities. We are currently in trials at one of the world's largest agricultural processors, a global management consulting technology services and outsourcing company, and a large North American energy company.

In the VoIP networking segments, some examples of our current installations include a multibillion dollar international mining company, a $1 billion New York Stock Exchange listed company, which, when the network is completed, will result in a 40-site, 16-country VoIP network; also one of the world's largest providers of business outsourcing solutions, and a global provider of high performance data networking equipment; also one of the world's largest soft drink companies, the largest cinema company in Japan, and a large Latin American retail chain. All these are in the VoIP networking segment.

In enterprise mobility segment, we have initiated relationship with another company that is developing enterprise mobility applications. Some recent installations with this organization, and I might point out these are all revenue that has been recognized, these installations include a leading manufacturer and marketer of home appliances, one of the largest futures exchanges, a leader in telecommunications and technology, a leader in wireless communications, and a cable and satellite television network. These are in the enterprise mobility sector.

A relatively new segment of the VoIP equipment market we are now entering is the SIP trunking market. SIP trunking is a method of delivering telephony services to businesses using VoIP access as a replacement for traditional PSTN services. Frost & Sullivan forecast SIP trunking lines to increase from 525,000 lines in 2005 to 14.5 million in 2012. NET's products are being developed to address the equipment needs of this market. We have been reselling our VoIP switches in the US through one of the largest communications companies in the world and now have more than 150 corporate installations. In addition, we are working with the following VoIP service providers. Box Telecom, a South African service provider which is building out a network to deliver enterprise VoIP services. IDT, a large telephony provider offering wholesale VoIP services to other service providers, and AccessLine, a US service provider that is the first to use our new auto provisioning capability to simplify service deployment.

We also saw significant growth in our secure voice segment in fiscal '08. Our secure voice solutions were incorporated into a number of DOD programs, including deployments for the US Navy, Marine Corps, Army, and Air Force. These programs included a shipment of our VX systems for the US Air Force IP communications equipment program, which is the next generation Air Force integrated communication access package.

We also delivered additional VX platforms to NATO for use in supporting the coalition forces in Afghanistan. We shipped our first major order for the VX1800 to a joint service command within the Department of Defense, which provides layer two transport of secure voice applications for special operations missions. And we are now in the process of developing new VX platform features to support the next generation of secure voice solutions for the Defense Switched Network or DSN. These features are expected to be delivered in the second half of fiscal '09.

The second market we are addressing is the multi-service access market where we offer compact, rugged, high reliability solutions for government and industrial applications. NET products enable our customers to converge legacy voice, video, and data services to an efficient IP infrastructure in environments where mobility and reliability are critical. NET continues to support a variety of government applications with its multi-service access solutions including the following recent wins. The delivery of part one of a two-part program to upgrade the United States Marine Corps digital control systems, and the delivery of our first major order for NX1000 systems in support of the war fighter program within the Department of Defense.

The scalability, small size and high bandwidth capability makes the NX1000 ideal for tactical deployments while providing reliable secure quality of service. We also shipped additional products to expand the defense satellite communications control center TelePort generation program, which allows the war fighter additional bandwidth for satellite gateway facilities.

And finally, in the high performance computing and networking market, we are targeting high-speed, low latency InifiBand extension solutions that extend InifiBand's fabrics over long distances to provide multi-gigabit connectivity between geographically dispersed servers and storage. This allows customers the ability to support the real-time data synchronization, backup, and disaster recovery required for building virtual clusters used in (inaudible) located in multiple sites across their campuses and their WANs.

The integration of Quintum Technologies, which was acquired in December of last year is proceeding well and we are already seeing the strategic benefits of the combination and have already begun pursuing joint marketing opportunities for converged VoIP solutions worldwide.

Operationally, we made a number of changes throughout the year to streamline our business and lower our cost structure, including the partial sublease of our former manufacturing facility and the move to Microsoft Dynamic AX to simplify our ERP systems and reduce associated cost. We also extended our GSA schedule contract until January 2010.

Organizationally, we added several new executives to our management team. This included Jack Steeg as Vice President of North American Enterprise. Jack who has had extensive experience in executive leadership in sales roles will lead NET's enterprise sales force. Jack had held senior management positions at NCR, Dell, and Unisys. We also brought on board two operations executives. Pete Patel joined NET as VP of Operations. Previously, Pete held senior management positions at Occam Networks, Advanced Fibre Communications and Ericsson. And John Fossett has joined us in a new role of Vice President of Manufacturing Operations. He was most recently Vice President of Operations at Vernier Networks. And Chuck Rutledge who was Quintum's VP of Marketing was promoted to the role of Vice President of Corporate Marketing for NET. In this role, Chuck will spearhead outbound marketing, corporate communications, and brand development for NET. These executives strengthen our organization and are already contributing innovative ideas and leadership throughout the company.

Looking ahead, fiscal year 2009 will be a year of execution for NET. We will continue to invest in our growth through product development and key partnerships while also keeping our eye out for strategic acquisition opportunities. In a moment, John McGrath will provide our financial guidance for fiscal 2009, but recognizing current economic conditions we will be cautious. We are encouraged by the opportunity we are seeing in our enterprise business with many of our programs and new initiatives for us and I believe the market will take some time to mature. We expect softness in the federal market in the current quarter but will expect to see the business improve in the subsequent two quarters.

At this time, I would like to turn the call back to John to provide detail on our financial guidance and some closing remarks.

John McGrath

Thanks, Nick. As Nick mentioned, we have many exciting things happening related to our enterprise business. As a result, we believe that we will see growth year-over-year. We also realize that our growth may likely be impacted by a weakening economy and election year government spending. We anticipate our fiscal '09 revenue to increase by 10% to 15% over the prior year. However, our Q1 will be challenging as we see government orders delayed including a $4 million DOD order that was expected in Q4 '08 that is now targeted in the December quarter of our third fiscal quarter. As such we expect a sequential decrease in revenue and may be relatively flat to down from Q1 last year. In the near term, we anticipate gross margin to remain in the upper 40s to 50 percentage range on a GAAP basis. We intend to continue to manage our costs at a level of revenue in order to maintain profitability and growth for fiscal '09.

As we end the fiscal year, we are pleased that we have grown profitability to a ten-year high. We enter this new fiscal year with new challenges related to the economy and political environment. However, we feel that the investments we have made, both organically and through acquisition and partnerships, have strengthened the company and we remain committed to long-term revenue growth, profitability, and shareholder value.

Operator, this concludes our prepared remarks. We would like to open the call now for Q&A. We request our audience to only ask one question at a time then re-enter the queue in order to allow us to take questions from everyone in a timely way.

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from Anton Wahlman. Please proceed.

Anton Wahlman – ThinkEquity Partners

John, I have a mathematical question for you and something is not agreeing in my Excel and I can't get it to change. Basically your pro forma non-GAAP income statement says $2.607 million non-GAAP net income and it 35,756,000 shares. When I do that division I don't end up with $0.09 but rather with – as you have in your table – but with $0.07.

John McGrath

Sure, Anton, this is one of those tricky things in the accounting literature that oftentimes don't makes sense to the average reader. But what isn't seen in the calculation is when you do the diluted earnings per share and it relates to the convertible debt that we issued in December, you have to add back the interest net of tax to the income and then you divide it by the increased number of shares. And so our interest net of tax is roughly around $500,000. And then hopefully that math will work.

Operator

And your next question comes from Greg Mesniaeff. Please proceed.

Greg Mesniaeff – Needham & Co.

Yes, thank you. I was wondering if you could repeat the percentage of revenues in the quarter that was from government, that's my first part of my question.

John McGrath

Product revenue from our government business increased 15% [ph] from Q3 to $24.6 million. So essentially it's 24.6 divided by 30.2.

Operator

And your next question comes from Eric Buck. Please proceed.

Eric Buck – Brean Murray

Yes, it's Eric Buck. Actually I was hoping you could go through kind of the full breakdown of the revenue stream between NX, VX, legacy products.

John McGrath

Yes, let me get those numbers in front of me. For the quarter – our – okay, for the quarter we have about a little less than 40% of our revenue comes from our voice products, which is a combination of the VX as well as the Tenor which we got from the Quintum acquisition. And then for the NX – for the Promina it's about 50 – it's pretty consistent with what we have been running for the prior quarters at about 55%-ish and then the rest is NX.

Operator

(Operator instructions) And we have a follow-up from Greg Mesniaeff. Please proceed.

Greg Mesniaeff – Needham & Co.

Yes, thank you. I think the questions got abbreviated. I was still in the midst of my question, which is if you look ahead given what you said about the expected slowdown in the government business, what are you – what kind of visibility do you have on the enterprise side particularly given the relationships you've been building with the various channel partners for UC?

Nick Keating

Greg, it's Nick. One of the things that I tried to do in my section was to talk about the VoIP market because that's the major emphasis right now that we have for the enterprise. It's not to say that we are not selling the multi-service end of the enterprise as well as we've got initiatives on the NX5010 for the enterprise also. But the majority of our effort right now is on the whole VoIP market. And we try to break that down into those different categories that I went through. What we are doing right now is we are building up our enterprise sales organization both domestically and internationally and that was the reason we brought Jack Steeg on board. We have got a requirement for another three or four enterprise sales guys in the United States. We have obviously added some additional people internationally. We are pursuing these partnerships that I mentioned at the same time and we've really targeted the large systems integrators. There are some that we are working with right now that we haven't announced yet that have brought us into trials. One of the integrators that we hope to announce in the not-too-distant future has brought us into three trials, and the trials are really the key for us. The more trials we have, the larger the longer-term revenue opportunity. We are starting to sell some pretty good-sized networks. This network of (inaudible) $1 billion New York Stock Exchange listed company, by the time it's built out we will have about 40 locations in 16 countries and so we are getting some, what I would call, good traction into that area. And then this other category that we talked about, enterprise mobility, again this is an unannounced relationship, but we have been able to sell five networks already in cooperation with this partner. And I think I've mentioned in the past that the enterprise mobility is a related fixed-mobile convergence type application and we are seeing traction there. I think what you will see is that each quarter you will see consistent improvement in the enterprise and our goal is to have all of the partnerships in place by the end of the financial year and be working very closely with all those partners. So we have a lot of visibility on pipeline and trials right now and the challenges to convert them into revenue.

Operator

We have a follow-up question from Eric Buck. Please proceed, sir.

Eric Buck – Brean Murray

Yes, I'm just trying to figure out the guidance here in the first quarter. I mean as I look at the fourth quarter here it looks like you had nearly $10 million of enterprise-related revenue, which means that if we look the first quarter unless you are expecting enterprise to go down as well and I am not sure why that would necessarily be the case, the government being half of what it was in the fourth quarter, is that – am I reading that correctly?

Nick Keating

Let me give you a little flavor to the government business. We are seeing some softness right now in two areas. In the 5010 area we have been sitting on an order now for over a quarter where the customer has said well, I don't have my funding yet. As soon as I get it that I'm going to release and let you ship that. And that's a follow-on to an existing network. And then the other area that we've seen delays, I mentioned this Marine Corps order that we shipped. That order was originally scheduled in November. It didn't come in November, it didn't come in December, it didn't come in January, finally came in the last part of February, and we were able to ship that order. Now, that's the first phase of a two-phase program. What we originally were told was that second phase would occur one month after the first order and that's the one that John alluded to that we were expecting in March or in a worst-case April and we are now being told it's probably not going to be until November, December. So, we are not quite sure whether this is a one-quarter phenomena or not.

Historically, the September quarter is very strong in the government because that's the government's end of fiscal year and if you look back historically we always have had strong bookings and those bookings not only contributed to revenue in the September quarter, but usually spilled over and contributed to revenue in the December quarter. So right now we are taking a relatively cautious view of what could happen. There are a lot of programs out there, but we are hearing that they are just deferring them.

Another one of the programs that we had was this win for the war fighter program or the WIN-T, and we did get orders for that and shipped in the March quarter. But now we are concerned that that may push out for a quarter or two before we see more orders. And so it's for that reason that we come up with the cautious attitude. At this point, I don't see that same degree of caution that's in the enterprise.

Operator

(Operator instructions) And we have a follow-up question from Anton Wahlman. Please proceed, sir.

Anton Wahlman – ThinkEquity Partners

Yes, a couple of things here. First of all, on the OCS stuff for Microsoft, kind of timing of the ramp? And also maybe I didn't hear you correctly, John, but I mean did you actually say what the Quintum revenues contribution were in the quarter you were speaking about there for a while?

John McGrath

Yes, I'll take the Quintum question and I'll turn it over to Nick to provide more color on the OCS. The way we are looking at the business now, Anton, is – and this is what we had said when we announced the acquisition is we are looking at Quintum as fitting in nicely to and end-to-end solution that we have now to bring forth to our customers. And so the marketing now will be done on an end-to-end basis. So through Quintum channels they'll have access to the VX and then through our direct and our channel set NET brought to the table they too will provide an end-to-end solution. And so we don't really look at that business internally as a Quintum business or an NET business but rather as a combined voice business and as such that's the way we would like the outside world to look at it as well. And so we don't break it out internally and we probably will not break it out externally. Nick, did you want to go ahead and–?

Nick Keating

Yes, just a couple other things. One of the things we are doing now is we are starting to consolidate the sales organizations together also. So the majority of the Quintum international distributors now are being managed by our VP of International here. The sole exception of that is the Quintum operations in Asia that are managed out of Quintum's Shanghai office. As John indicated, we are now private branding Quintum products under the NET name and NET products under the Quintum name and we are also doing joint sales calls for larger integrated solutions where you need a mixture of both NET and Quintum products. So we felt that it was no longer appropriate to try to treat them as separate organizations as the integration has proceeded very well.

Going on to your UC question, I think the issue that we are faced with since we did not have an installed base that you would find at let's say a PBX vendor would have, in every case what we have to do is to go in with the integrators, go into the trials, and then if the trials are successful then convert those customers to revenue. The level of trial activity is increasing. The closer we work and the more experience that we have with some of these integrators the more often they are being brought in to their large customer situations. And I think this will just be on a continuous basis. As each quarter goes by I expect the UC market to continue to evolve and expand. It's important that we work with as many partners as possible because what we find is enterprise customers all have their preferred or favored integrator that they have worked with in the past.

Operator

And your next question comes from Marc Abizaid. Please proceed.

Marc Abizaid – Mohican Financial

Hi guys. Can you talk about your acquisition strategy? And are you still actively looking for acquisition targets? If so what size you are looking for and do you expect the acquisition to be accretive?

Nick Keating

Let me start with – our goal clearly is the acquisition should be accretive. You may not have an accretive acquisition that takes place immediately right out of the gate, but certainly within a twelve-month period I would expect that any acquisition that we did would be accretive. From a criteria standpoint, we really have three focus areas, and we would expect any acquisition to fit in one of those three focus areas. That's government systems, voice, and mobility or broadband. We do not intend to move outside of those three categories. Typically, we would look for a company that has revenue; that has product; that has a sales organization; that has referenceable customer base; and a reasonable amount of revenue. I could not see us doing purely a straight technology acquisition or a real early stage company. Our sense is it probably should have $15 million to $20 million in minimum revenue but we would not be opposed to acquiring a company that was in the $35 million to $50 million range. I think anything beyond that probably is outside of our grasp right now as these acquisitions usually go for at least two times revenue and a $50 million acquisition would probably have a minimum price tag of $100 million on it.

Operator

And your last question comes from Greg Mesniaeff. Please proceed, sir.

Greg Mesniaeff – Needham & Co.

John, I was hoping you can once again repeat the guidance as you've stated it just so I can kind of put all the pieces together in one convenient area.

John McGrath

Okay, I'll go ahead and read what I said on the guidance here, so let we put my glasses back on. We anticipate our fiscal year '09 revenue to increase by 10% to 15% over the prior year. However, our Q1 will be challenging as we see the government orders being delayed. We had talked about the $4 million DOD order that was pushed out. That's now targeted for our December quarter. And so with all of that, we expect to see a sequential decrease in revenue, which may be flat to down from Q1 of last year.

Greg Mesniaeff – Needham & Co.

Okay. And also as far as margins, any guidance or any directional commentary?

John McGrath

I have two more bullets. As far as the gross margin we expect them in the upper 40s to low 50s. It's really going to be dependent upon the level of revenue. Obviously, you have to spread those fixed costs, so if revenue goes down it impacts our margin as well as the sales mix. And so it could be in a range depending upon those two items. And then we also intend to continue to run the business for the entire fiscal year to remain at a profitable level and to continue to grow cash. That was the guidance.

Operator

At this time, I would now like to turn the call back over to Leigh Salvo. Please proceed.

Leigh Salvo

This concludes our prepared remarks and Q&A for today. Thank you all for joining us. We will be out on the road in the next couple of months meeting with investors in New York, Boston, and the Midwest. We hope to see many of you then. Thank you very much.

Operator

Ladies and gentlemen, this concludes your participation in today's conference call. Please disconnect. Good day.

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