Netscout Systems Inc (NTCT) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to NetScout's third quarter operating results conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given to you at that time. And as a reminder, this conference 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 for opening remarks I would like to turn the call over to Mr. Singhal. Please go ahead, sir.

Thank you and good afternoon everyone. Welcome to NetScout's third quarter of fiscal year 2005 conference call for the quarter ended December 31st.

I will begin the call today with a brief overview of our financial results achieved this quarter, followed by a summary of our operating highlights for the recent quarter and past fiscal year. David will then review the financial results for the quarter in greater detail.

First let me turn the call over to Cathy Taylor, Director of Investors Relations, who will read the safe harbor statement.

Thank you, Anil.

During the course of this conference call, we will be providing you with a discussion of the factors we currently anticipate that may influence our results going forward. Before doing so, we want to emphasize that these forward-looking statements may involve judgments and that individual judgments may vary. Forward-looking statements include expressed or implied statements regarding future economic and market conditions, revenues, profitability, growth, 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 necessarily inform you when they do. Our Company policy is to provide guidance only at certain points in the year such as during the quarterly earnings call. We do not plan to 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 provide today are still valid. These and other specific factors could change causing our projections not to be achieved. The specific risks and uncertainties are discussed in NetScout's Form 10-Q for the quarter ended September 30, 2004, on file with the Securities & Exchange Commission.

I will now turn the call back over to Anil Singhal, our Chief Executive Officer.

Thank you, Cathy.

Once again we are pleased with the strong results as we achieved better than expected performance. Revenue was $22 million compared to last quarter's revenue of $20.5 million and compared to $18.9 million a year ago. We have a net after tax profit of $906,000 compared to last quarter's $1.1 million net profit and compared to $183,000 a year ago.

Our earnings per share were $0.03 per share which was on par with last quarter $0.03 per share and compared to $0.01 per share a year ago. Our cash flow from operations was positive with cash increasing by $1.1 million to a total of $79.3 million.

We exceeded previously issued guidance for the quarter and we created growth in revenue for the sixth consecutive quarter. While much of the success is attributable to the continued momentum and traction of our CDM strategy, the results of this quarter also benefited from end of calendar year spending.

Looking ahead we expect revenues in our fourth quarter to be flat. In addition, we are entering our fourth quarter that has traditionally had high operating expenses due to the seasonal effect of payroll taxes and higher health insurance costs. We also expect to incur increased costs related to Sarbannes-Oxley compliance. All of these effects are factored into the guidance for the next quarter that David will be providing at the end of the conference call. All in all, we are very pleased with our performance and feel that our CDM strategy continues to provide a clear competitive differentiator for us in the marketplace.

Now turning to the product highlights of the quarter. During the quarter, we announced a number of new products and unveiled a new strategic initiative called High Definition Performance Management, or HDPM, which represents the next major evolutionary step for our patent pending CDM technology. HDPM will provide a high of degree of detail and granular visibility of all application across the network. It will provide more granular measurement of application and network traffic statistics at tighter intervals that will aid in faster problem identification and troubleshooting. This increased level of granularity is very important on high-speed converged networks where a lot can happen to interrupt hard flow applications and business services in a very short amount of time.

More detailed visibility can also facilitate the quick deployment of new applications like Voice Over IP, Multi-media, MPLS, and IP Multicast, while helping control the spread of non-productive peer-to-peer applications like Kazaa. Finally HDPM opens the door for solving increasingly complex problems such as identifying hidden trends in the network usage or spotting traffic anomalies and potential quality violations, all in real time. We've reviewed our high definition initiative with customers at our user forum last October and we are extremely pleased with the positive feedback.

And now on to other new product announcements. This quarter we launched the nGenius Flow Recorder appliance, an audit trail and network forensics tool that provides continuous recording of network traffic and can be used for virus detection, session replay and the ultimate detail in troubleshooting. The Flow Recorder differentiates itself from competitive solutions by covering multiple segments and all network topologies with our best-in-class graphical client and reporting features. We also announced the nGenius Flow Collector, a dedicated appliance for high-volume collection of NetFlow conversation records. The Flow Collector provides a flexible and highly scalable means for IT operators to leverage the performance data available within their existing infrastructure devices in order to apply the powerful analysis and reporting of nGenius Performance Manager

Other product announcements include a new high-density probe that is the market's first solution for monitoring up to eight segments on T1/E1 wide area networks. Increasingly T1/E1 circuits are being used to connect corporate data centers with multiple remote offices. This probe helps solve the challenge of monitoring critical traffic activity and utilization in a cost effective, high-density manner.

In summary, we are pleased with our steady revenue growth and market acceptance of our new products and the CDM strategy. We plan to grow in addition by creating new and expanded relationships with both product partners and resellers, some of which we expect to announce shortly. We continue to work closely with our customers and set new standards for performance management. We believe we have the broadest and the most powerful performance management solution on the market today. We look forward to announcing further details about new market leading products and high definition enhancements to our nGenius solutions in the coming quarter.

With that, I would like to turn the call over to David.

Thank you, Anil.

I would now like to review our quarterly financial results. Those results are contained in the financial statements included with our press release this afternoon.

Revenue for the third fiscal quarter of 2005 was $22 million, a 16 percent increase over the third quarter of fiscal year 2004 and an increase of 7 percent over last quarter. Our product revenue increased 18 percent from a year ago and 8 percent over last quarter. Service revenue increased 5 percent yea-over-year and 7 percent versus last quarter. License and royalty revenue was down 4 percent from a year ago and 5 percent from last quarter. Revenue through our direct sales force was 46 percent of the total, compared to 36 percent last quarter. Reseller revenue correspondingly was 54 percent of total revenue, compared to 64 percent last quarter.

During this quarter, we added 36 new customers worldwide representing 13 percent of total orders, up from 31 new customers in the second quarter. Among some of our largest new customers are Deutsche Telecom, Discovery Communications, Nextel Argentina, the National Security Information Center in China, and Northwest Farm Credit Services. We had 296 repeat customers this quarter representing 87 percent of order volume, up from 249 in the second quarter. Some of our repeat customers include Wachovia, Vodafone, NVP Paraba (ph), Consumers Energy, Kaiser Permanente and Goodyear Tire.

We had 58 customers with order volume over $100,000 this quarter, including 4 customers with order volume greater than $500,000, and 2 customers over $1 million. Competitive wins totalled more than $4.7 million in the third quarter involving approximately 29 deals against other leading network management vendors.

Turning now to our vertical markets. This quarter the financial services sector was strong with 47 percent of order dollar volume followed by the government sector with 11 percent of orders and telecommunications with 8 percent. The health care and manufacturing sectors each represented approximately 6 percent of order dollar volume.

During the quarter, 1 of our 7 figure deals came from one of the world's largest investment banks. This bank is in the process of enhancing a network that provides service the more than 600 remote retail sites. We won this competitive bid against one of our primary competitors. During the evaluation process, our solution demonstrated the ability to quickly identify and troubleshoot problems including anticipating application rollout issues during the design process. Included in the deal were several of our nGenius Flow Recorder appliances, which will be used to help collect every transaction from newly developed applications for post event forensics. Some of the nGenius Flow Recorder appliances are also being deployed to aid in troubleshooting at key WAN consolidation points by recording all traffic from the 600 branch locations.

One of this key reasons NetScout was selected for this project was the ability to distinguish automatically among the remote locations in the network. In addition we're able to track the delivery and the performance of complex multi-media applications including streaming video and radio, and then help to validate the resulting charges from numerous content service providers. An added benefit was the nGenius system's ability to monitor and troubleshoot Voice Over IP traffic simultaneous with, and in the context of, their business application activity.

We had more exciting news during the quarter coming from the Federal Government. We recently participated in the Joint Warrior Interoperability Demonstration or JWID, sponsored by the Joint Chiefs of Staff. This annual event demonstrates new and evolving technologies in a simulated warfare environment involving U.S. military commands and NATO countries. This year's focus was also homeland security. Our participation in this event was sponsored by the Defense Information Systems Agency and we're pleased to report that NetScout was listed one of the stop 9 performers out of 61 trials. The report stated that NetScout was, "a powerful and easy to use tool for network analysis that could be used to create a core network solution for implementation on operational networks."

Out of the 9 top performers, NetScout's solution was 1 of only 2 that are commercially available. The others are all government developed. And was the only one that addresses network and application performance management. As a result, NetScout is now recognized as the only JWID preferred commercial technology provider for network and application performance management for war fighter capability and homeland security deployments over the coming 12 to 18 months.

Turning back to our financial picture, our gross profit for the quarter was $16.8 million, up 17 percent year-over-year and 9 percent sequentially. The gross margin was 77 percent in the quarter up 1 point year-over-year and up 1 point sequentially, and above our gross margin target of 72 to 75 percent.

Revenue from international sales was 24 percent of total revenue up from 18 percent last quarter, with Asia representing 4 points of the total and Europe 20 points. The European strength was principally from financial services and telecom sectors. Our new Deutsche Telekom win is the largest element of that business. Deutsche Telekom is using our solution to monitor their customer facing internet service delivery network.

Operating expenses in total were $15.8 million, up 12 percent year-over-year and 8 percent from last quarter. The increase in expense resulted in part from the partial reinstatement of our non-sales incentive compensation plan.

We had an operating profit of $1.1 million. The net after tax profit for the quarter was $906,000 versus a net after tax profit of $184,000 a year ago and $1.1 million last quarter.

Turning now to key balance sheet measures. Cash and marketable securities are $79.3 million, an increase of $5.6 million year-over-year and $1.1 million from last quarter.

Accounts receivables, net of allowances, were $13.2 million compared to $9.7 million dollars last quarter and $9.5 million a year ago. Day sales outstanding were 54 days for the quarter up from 42 days in the prior quarter and within our target range of 45 to 55 days. The increase in DSO was caused by strength in Europe and by a back end skew to revenue through December . Inventories were $3.1 million up slightly from last quarter.

And now for our guidance. We're only issuing guidance for the March quarter today. We expect fourth quarter revenue to be in the range of $21.5 to $22 million. We expect net income earnings per share to be in the range of break even to $0.01 per share. As Anil previously mentioned, we will have an increase in operating expenses in the March quarter due to the seasonal affect of payroll expenses, due to Sarbannes-Oxley expenses, and due to higher health insurance costs. This is the conclusion of our guidance. We plan to provide further guidance at the end of each quarter in our succeeding conference calls. We do not plan to and disclaim any obligation to provide updates to this information even though our expectations may change during the quarter.

And now Anil and I will take your questions. Please go ahead, Chuck.

Thank you. (OPERATOR INSTRUCTIONS) And our first question comes from Richard Sherman with Janney Montgomery Scott. Please go ahead.

Good afternoon, Anil, David, Cathy. My question was about the -- I guess the new recorder product. How much of this business -- how much of this product is being directed towards some of the compliance requirements that are starting to emerge? And was that a driver? How much of business is being driven by those compliance issues today?

I think that compliances is a very general word. Initially the purpose is more on the security forensics side. But I think it can be used for audit trails, so in that sense, it can be used for compliance. But this particular customer was more on the security forensic side.

Okay. So going forward I mean is this -- are we starting to see, particularly in Europe, are we seeing some requirements for more of this recorder type of functionality?

I think it's complimentary to what we already do. We record data, but only for a short amount of time. So if you have intermittent problems, whether it's on the compliance side or whether it's on the performance side, then you have to record everything in anticipation of something you may want to look backward. So typically if you look at our standard product, it has two main uses. One is real time and other is reporting over multi-day -- I mean, for long term historical purposes. And you preserve the data for weeks and months at a time.

In the case of Flow Recorder, it somewhere falls between real time and reporting. You would record everything rather than just top end information for a couple of days or 4 or 5 days at a time. Just in case you have to go back for either compliance, audit trail, or forensic purposes.

All right. Then my question was on the gross margin line, you know, bounce back up here this quarter above your long term target. Can you give us a sense on the sustainability of high, mid to high 70s, a gross margin number?

Sure. As we've been saying, we continue to believe that gross margin above the 75 percent level is temporary. We expect as growth continues, to have product -- the product component of our revenue mix grow. And because of the hardware involved in the bulk of our product line, those gross margins are below the average. So they will, as growth accelerates, we hope, pull that gross margin down some.

In addition, we're -- we are continuing to enhance our relationships with resellers of various sorts. And as we do that, the pressure on gross margins will increase slightly. So we're holding our 72 to 75 long term target for gross margins despite our out-performance of that.

Okay. All right, David. Thank you.

Thank you.

We have a question from Eric Martinuzzi with Craig-Hallum. Please go ahead.

Hello?

Yes this is Eric from Craig-Hallum. You got me.

Yeah, we can hear you.

Question has to do with the Federal Government deal. And again, and it may be a follow-up to the prior question. But the recorder -- and I don't know if that was the key driver there for JWID. But does this imply that's it's going to a greater demand out of Federal Government for the types of products that you provide? Or is this just an example and we shouldn't expect Federal to be a bigger percentage of pipeline going forward?

Eric, let me start by sort of correcting things. I may have confused you a little bit. The Flow Recorder implementation was part of the financial services institution example that we cited, not part of the Federal Government.

Okay.

The Federal Government win was a design win, if you will, in this JWID demonstration which is done annually. And we have been working on that with our newly enhanced and larger federal sales team, which is starting to get some traction and some success. And this is one very important to us, we think, illustration of that.

And we do believe -- it's certainly our intent that this will be a precursor of a much stronger federal business, not only on the defense side, where we've had some significant success in the past, but also on the civilian side where homeland security and defense was also included in this defense -- reviewing the results of this demonstration -- the JWID demonstration. So we certainly hope that it's precursor of more strength in the federal business for us.

We certainly -- as the Federal Government on both sides increases their use of networking and increasing their interoperability, which is of course one of the major themes of homeland security, their networks get much more complex. As that happens, then the need for management and performance escalates and that's where we play strongly. We're very encouraged by this.

Okay. And then on the guidance, I understand the calendar year end versus your guys fiscal year end issue. But just to juxtapose, last year you did see sequential growth between Q3 and Q4. Is this a case of you just not wanting to forecast that based on the pipeline? Or is it truly -- that's exactly what you expect -- sequentially down would not surprise you?

Well as Anil characterized that, I think we're saying that it's flat. We are -- we are cautious about some of the information that's in the industry about sort of declining growth in tech spending as the CIO surveys come out.

We have good visibility into the March quarter so we're confident in the numbers we issued. But we are cautious because the upturn in tech spending that everyone was predicting a year ago, including us, hopefully, has been very modest. And some of the more recent surveys have indicated that growth and tech spending may be declining. Not shrinking, but lower growth numbers. So we are cautious about the coming quarter for that reason.

Okay.

In addition, of course, the -- as you pointed out, the calendar quarter is the time when most of our customers reset their budgets. So although we have on-going -- a good on-going pipeline coming into the quarter, much of the decision making on that pipeline -- the projects that make up that pipe line is now subject to final budget setting, which is underway. So it's difficult to predict in this quarter exactly how many of those may come to fruition in the quarter. And so there is greater uncertainty in our March quarter than typically in our December quarter.

Okay. Then lastly, you did see a good year-on-your revenue growth. I think it's 16 percent -- is that the number?

Yes. Yes year-over-year.

The other thing I noticed was the total expenses seem to be up, not quite as much, but up about 13 percent.

I think it's actually 12. But maybe that's rounding.

You've got the operating expenses. I'm grounding everything. But whether it's 12 or 13. I was hoping and, not taking anything away from the growth, but I was hoping to see more leverage. I do understand the Sarbannes-Oxley, incentive comp, the health insurance, but is there a point where the model really starts to show some leverage to sort of break us out of what would have been positive earnings but not markedly higher?

Yeah I think you will see, Eric, when quarterly revenue gets into the high 20s that our operating leverage will -- we will be back at our target operating margin model of the high teens. And in the process of getting from 22 million a quarter to the high 20s, you will see significant operating leverage.

We have some things to overcome and you just highlighted them. In the process of doing that. And most of them are not unique to NetScout, but nonetheless we have to overcome them. And that will cause the operating leverage to be delayed a little beyond -- in that growth path a little beyond where we hoped it would be when we started this growth 2 years ago or 18 months ago. So that's really the issue that's -- we're not -- we would like to see more operating leverage sooner. But Sarbannes-Oxley and health care costs and other things have limited our ability to do that.

Okay thank you.

Thank you.

If there are any additional questions please press star, 1 at this time. We have a question from Joseph Craigen of Needham and Company. Please go ahead.

Thank you. Good afternoon.

Hi, Joe!

First off just wanted to follow up kind of on the expense issue there. Can you just update us where you are on your sales hiring plans and how that perhaps plays into the expense guidance?

Sure. Pardon me. We have a snow storm going on here and we're all catching colds. Of course you know that, Joe.

We are pretty far along on on our sales hiring plans. We have 48 account managers, which is up slight from prior quarter. We're heading for the low 50s by the end of this quarter. And so we will -- we are still hiring full force. We're hiring very selectively. We haven't experienced -- the good news is we haven't experienced extensive turnover recently in the sales force. So that's a good sign. But sales expense growth is part of what happens to us at the end of the year in part because we have continued hiring and also in part because salesmen are entering their quota years. And so there's a big push on, as happens with every company at the end of the quota year. And also as our revenue grows obviously the commission expense component grows proportionately and, as we hit the end of the quota year, sometimes disproportionately accelerators kick in.

Now, would this quarter -- would that be -- would you have completed the bulk of the hiring plan for the near term? This quarter.

That's our intent, yes.

A little more high level here -- just looking at it at the landscape here with perhaps not direct competitors, but people in the space here -- Concord going out and buying Aprisma, EMC buying Smarts. Do these acquisitions that are going on, does that change at all, number one, the competitive landscape for you guys, and number two, does it change how you think about the product road map?

Short term, we don't see any impact of this. We, about 2 or 3 years ago, when we started on the CDM strategy, we identified 3 distinct market segments. One is system management. And the other one was the support management and third was performance management.

We committed to the marketplace and our customer that we'll provide a total solution in the performance management space. And we'll be complimentary on helping the other spaces but we are really not directly playing into those areas. So for example, you will see Aprisma, Smarts or Micromuse, but really we will not be going after those budgets. So we continue to have the same plan. And because of that, we don't see any short term, unless we make some changes to our strategy, any impact of these acquisitions.

Okay. That's it for me. Thank you.

Thanks very much, Joe.

Mr. Singhal and Mr. Sommers, there are no further questions at this time. Please continue with your closing remarks.

All right. Well thank you all very much for joining our third quarter conference call. We're pleased with the quarter and thanks for your interest. We hope to see you on the call at the end of our fiscal year in May. Thank you.

Thank you. Ladies and gentlemen this conference will be available for replay after 8:00 p.m. Eastern time today through midnight Eastern time on Wednesday, February 9th. You may access the AT&T executive playback service at any time by dialing 1-800-475-6701 and entering the access code of 765874. International participants, please dial 320-365-3844.

That does conclude our NetScout third quarter operating results conference call for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.