Netscout Systems Inc (NTCT) 2006 Q1 法說會逐字稿

Welcome to the NetScout first-quarter conference call. first-quarter conference call. (Operator Instructions) As a reminder, this conference call is being recorded. With us today is NetScout's President and CEO, Anil Singhal. Accompanied by NetScout's Chief Financial Officer, David Sommers. Also, with Mr. Singhal is NetScout's Director of Investor Relations, Miss Cathy Taylor. At this time for opening remarks, I will turn the program over to Mr. Singhal.

Thank you, and good afternooneveryone. Welcome to NetScout's first-quarter fiscal year 2006 conference call for the period ending June 30th.

I will begin 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 our high-level goals for the future. Later, David will review our financial reserves and Company performance in greater detail.

First, let me introduce you to Cathy Taylor, Director of Investor 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 judgment and that individual judgments may vary. Forward-looking statements include express or implied statements regarding future economic and market conditions, the company's revenues, profitability and growth, and delivery and market acceptance of NetScout products. It should be clearly understood that the projections on which we base our guidance and our perceptions 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 make today are still valid. The risks and uncertainties that could cause our projections not to be achieved include risks and uncertainties that are discussed in NetScout's Form 10-K for the fiscal year that ended March 31st, 2005 on file with the Security and Exchange Commission. I will now turn the call back over to Anil Singhal, our Chief Executive Officer.

Thank you, Cathy. We had another successful quarter, making it our biggest quarter of sequential revenue growth with revenues up 17% year-over-year. Our revenue for the first quarter was $23.5 million compared to revenue of $22.6 million in the previous quarter and revenue of $20.1 million in the first quarter of last year.

Net profit for the quarter on a GAAP basis was or $652,000 or $0.02 per diluted share, compared to net profit. of $610,000 or $0.02 cents per diluted share for the previous quarter and compared to a profit of $297,000 or $0.01 per diluted share in the fourth quarter of fiscal year 2005.

Starting this quarter, we will begin to report earnings on an adjusted basis. Adjusted net profit excludes non-cash acquisition, and stock-based compensation expenses on a tax adjusted basis. We believe adjusted earnings better reflect NetScout’s operational trends and performance. A reconciliation between the GAAP numbers and adjusted numbers may be found in the copy of the press release found in the Investor Relations section of our website. On an adjusted basis, the net profit for the first quarter was $945,000 or $0.03 per diluted share versus $610,000 or $0.02 per diluted share a quarter ago.

On an operating basis, we continued our improving trends. We grew our adjusted operating margin to 4% up from 2% in the prior quarterand we are making progress towards our operating target of 10% adjusted operating margin in the fourth quarter. Overall, we are on track to achieve our goal of 15-20% revenue growth for the fiscal year.

Currently, there several major trends in the market that are increasing demands for our solutions. First, the momentum of the IP-based convergence movement has accelerated both in the large enterprise and carrier markets, bringing with it increased management complexity. Second, multi-tier and web-services-based applications, which are more sensitive to the performance of the infrastructure, are proliferatingin the enterprise market. Simultaneously, the business impact of performance degradation is steadily increasing, and the network operations team has to accept ever-greater responsibility for the specific applicationservicelevels delivered. These factors combine to necessitate a new, exceptional level of visibility and a far shorter time lag in identifying and resolving performance problems. NetScout’s High-Definition Performance Management, or “HDPM” initiative is our comprehensive response to these new requirements.

The goal of HDPM is to empower the network operations team to stay ahead of the curve as both complexity and service level expectations increase. HDPM recognizes the need for faster problem detection, and effective problem escalation, as well as powerful diagnosis, in the service of lower ”Mean Time To Repair”. The strategy has three major integrated components: First, an automated, actionable, early warning system for network operators;second, proactive network and application monitoring for networking engineers;and third, advanced packet or flow analysis for network specialists.

The first component is based on technology we acquired this past quarter and is on track to be launched by the end of the year. The second component, High-Definition Performance Monitoring, was launched in April with the release of nGenius Performance Manager 3.0 and Probe Firmware Release CDM 3.0. The third component is based on nGenius Flow Recorder, which was significantly enhanced in the 3.0 release in April. With this three-prong strategy, NetScout is bridging the performance problem life cycle, from discovery through troubleshooting, positioning to meet the needs of the emerging “application-aware” network operations center and increasing our strategic value to our customers. In addition, HDPM will act as a clear differentiator in competitive scenarios.

HDPM will also support our efforts in building strategic partnerships with leading enterprise management vendors who are laying the groundwork for their vision of adaptive, self-managing infrastructures such as IBM’s “On-Demand Computing” initiative and HP’s “Adaptive Enterprise”.

Along those lines, we have recently been working with HP and have completed an updated integration and certification of nGenius Performance Manager with HP OpenView. NetScout is now a Platinum Business Partner in the HP Enterprise Management Alliance Program and we'll be exhibiting at the HP Technology Forum in New Orleans in September. Platinum Level status will enable us to participate with HP in joint marketing.

In summary, we are pleased with our continued revenue growth,and we are energized by the market acceptance of our new products. We look forward to sharing some of the success stories with you in the coming quarter.

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

Thank you, Anil. It is my pleasure to review our quarterly financial results which you can find in the financial statements included with our press release.

As Anil mentioned earlier, beginning this quarter we will be reporting our results not only on a GAAP basis, but also on an adjusted, or pro forma basis, as a result of our recent acquisition of Quantiva. I will give you some specifics about the difference between our adjusted earnings and our GAAP earnings in a few moments.

We're reporting adjusted results, excluding the amortization of intangible assets and stock-based compensation from the acquisition. The expense amounts associated with these items are disclosed in parenthesis on the face of the GAAP income statement in our press releaseand summarized as supplemental information at the bottom of the statement.

We believe these adjusted financial measures will enhance your overall understanding of our current financial performance and our prospects for the future. We use these adjusted financial measures internally, for the purpose of analyzing and managing our business. Specifically, we believe the adjusted financial measures provide useful information to both management and investors by excluding certain charges that we believe are not indicative of our operating trends and performance.

In addition, we believe that the investment community has historically used our adjusted financial results to evaluate our financial performance, and we've historically reported both GAAP and adjusted results to the investment community. Revenue for the first fiscal quarter of 2006 was $23.5 million,a strong increase of 17%, over the first quarter of fiscal 2005, and 4% over last quarter. Our product revenueonce again drove the overall growth with a 30% increase from a year ago and up 5% over last quarter. Service revenue increased 2% year-over-year and increased 6% over last quarter. Revenue from our direct sales was 39%, compared to 48% last quarter due to a normal fluctuation in revenue content from our large financial services customers who are typically direct and increasing strength in our reseller relationships. Reseller revenue was 61% of total revenue compared to 52% last quarter.

During this quarter, we added 16 new customers worldwide, representing 7% of total orders down from 26 new customers in the fourth quarter, however, the total dollar volume of orders from new customers is approximately the same as last quarter. Among some of our largest new customers, World Span Technologies, Bechtel Corporation, Juniper Networks in Asia, Daimler/Chrysler in Europe, and the Bureau of Citizenship and Immigration in Canada.

We had 287 repeat customers this quarter representing 93% of order volume up from 278 in the fourth quarter. Some of our repeat customers include the Defense Intelligence Agency, BankNorth, Kaiser Permanente, Lowes, Sony, the Arizona Supreme Court and CSC Airline Solutions. .

We had 54 customers with order volume over $100,000 this quarter including five customers with order volume greater than $500,000, and one customer over $1 million.

Revenue from international sales was 21% of total revenue up from 16% last quarter, with Asia representing 5 points of the total and Europe 16 points. The upturn in our European business, which occurred principally in Germany, is a normal fluctuation driven by the lumpiness of large deals.

Turning now to our vertical markets, this quarter the financial services sector represented 28% of order dollar volume followed by a strong showing of the telecommunications sector with 15% of orders. The government sector came in at 14% of order dollar volume. The customer with order volume over $1 million is a repeat wireless service provider. Wireless service providers continue to be a growing vertical market segment for us as they deploy new third-generation networks delivering converged, voice, video and data services that require the same monitoring as enterprise networks.

Some of our large customer deals represented market share gains for us and validation of our unified solution strategy.

One of the companies is a global manufacturer of electrical systems with $10 billion in sales and 400 remote sites. Our solution is being used to monitor application performance over a meshed MPLS network for 40 sites in the U.S. Like many of our customers, this company has deployed nGenius in addition to Concord Communications’ Products, now CA, which were primarily used for utilization metrics. With expanded deployment of nGenius, the company achieved deep visibility into application details for intelligent troubleshooting of performance in their critical SAP and other applications as well as significantly reduced need for Concord. nGenius provided, therefore, a way to simultaneously consolidate their management systems, reduce expense and improve their management functionality.

Another competitive win came from an international golf course and resort management company with nearly 200 locations worldwide. Our nGenius Solution with Flow Collectors is cost-effectively monitoring conversation information from Cisco Netflow enabled devices between every one of their resort locations across a new MPLS VPN network, displacing previously installed Visual Networks products.

Turning back to our financial picture, our gross profit for the quarter was $17.7 million, up 15% year-over-year and 5% sequentially. Gross margin was 75% in the quarter, down 2 points year-over-year, and up 1 point, sequentially, and within our gross margin target range of 73 to 76%.

Adjusted operating expenses in total were $16.8 million, up 12% year-over-year, and up 3% from last quarter. Adjusted operating expenses are calculated by deducting non-cash expense of $79,000 of stock-based compensation expense, and $262,000 of amortization of intangible assets and in-process R&D from the GAAP operating expenses of $17.2 million.

We also adjust out $48,000 of tax, which is the offsetting temporary cash effect of these non-cash adjustments. In total, the increase in adjusted operating expense year-over-year resulted principally from increased sales commission and other employee-incentive compensation, increased marketing programs and the addition of Quantiva expenses. In addition, we spent over $200,000 on Sarbanes-Oxley compliance in the first quarter, in addition to the approximately $1 million that we spent last fiscal year. As a result of that substantial financial investment, plus the extraordinary efforts of our employees, we achieved Sarbanes-Oxley compliance for fiscal 2005.

Adjusted net profit for the quarter was $945,000, versus a net profit of $610,000 last quarter and up from a net profit of $297,000 a year ago.

Turning now to key balance sheet measures,cash and marketable securities are $77.3 million, a decrease of $6.6 million, principally as a result of the Quantiva acquisition. Year-over-year cash grew $781,000. Excluding the cash used in the Quantiva acquisition, cash grew $2.9 million from last quarter.

Accounts receivable net of allowances were $11.1 million compared to $11.9 million last quarter and $11.5 million a year ago. Days sales outstanding were 43 days for the quarter, down from 47 days in the prior quarter and below our target range of 45 to 55 days. Inventories were $3.1 million which represents no change from last quarter.

And now for our guidance. We're issuing detailed guidance only for the September quarter today. We expect secondquarter revenue to be in the range of $23.5 to $24.5 million. We expect earnings per share on a GAAP basis to be in the range of $0.02 to $0.03. On an adjusted basis, we expect earnings per share to be in the range of $0.03 to $0.04. In addition, we're reiterating our guidance for the full year of fiscal 2006. We expect 15 to 20% revenue growth and to reach 10% operating margin by the fourth quarter. 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. Now Anil and I will take your questions. Please go ahead, Operator.

[Operator Instructions] Our first question comes from Richard Sherman from Janney Montgomery.

Anil and David, good afternoon. Can you hear me? Could you talk about Flow Recorder?

Yes, we can. Thank you.

A couple of questions. Maybe, could you talk a little more about Flow Recorder. I know you talked about strategic initiative areas of your prepared remarks. But here you talk about the uptake of Flow Recorder, the attached rate, sort of similar type of questions that we had last quarter. I am trying to model in how many Flow Recorders per probes, or what kind of visibility you have into a Flow Recorder?

I think, we talked about the repackaging of the Flow Recorder 3.0 and some changes we are making. We are allowing the Flow Recorder to be directly attached to the line, instead of being attached to a probe as there was in the previous version.

There is no direct formula between the number of probes versus the number of Flow Recorders. And also, so far the Flow Recorder is a very small portion of the revenue in this quarter. We hope that will pick up with the new release of 3.0 in the coming year. It is still hard to come up with an attached rate. Sometimes a probe may be used in a different place than the Flow Recorder and not attached to the probe directly.

Anil, I know in many cases where you sold Flow Recorders, and I understand it is early now. What does it look to be? Does it look to be initial trials or actual multiple Flow Recorders that are deployed by some of your customers at this stage?

I think it is initial trial, but even in an initial trial, it is multiple Flow Recorders.

And maybe can you talk about some of those examples of how they are using it? Or currently, this customer has 65 probes, he's deployed 2 or 3 Flow Recorders. Give us some idea on that side.

Again, I think there is no direct matching but overall the number of Flow Recorders deployed by customer is substantially lower. I would say maybe 10% or even lower than that of the probe. But since the number of customers is much less compared to the number of customers for the probe. I think, I don’t want you to infer any trend from this. But overall people are looking for three or four things in the Flow Recorder. One is, if they were using a protocol analyzer in the past, which will be deployed after the problem. In this case, they will be recording date prior to the problem, and then going back to the data for either security issues or performance issues, or just troubleshooting a problem, which is very hard to duplicate.

Sometimes they will look at the Flow Recorders to look at spikes for a specific problems, and users are complaining about poor response time, and they want to investigate that particular time period and see what was happening during that time. So those are the few users of the product versus the probe where the probe has been used more for real-time monitoring, capacity planning and recording. There is overlap between -- slight overlap between the two products. So some people could use Flow Recorder in place of probes. But, overall, that's how we are positioning the two.

I understand. Now, Anil, should we think about compliance as being a driver for Flow Recorder?

I think we talked about that but we find that the compliance people are using a lot of -- we would love to see that as a big use of the product, but we find there are other tools available to people like log files from servers and all those, and those people are not traditionally using network management tools or protocol analyzers. So we see a bigger market in our traditional base where the primary use may not be compliance – the primary use may be performance analysis, troubleshooting. Maybe the second use is security and forensics, and the third use would be compliance.

And maybe one more question. In your comments, you said you had, I guess, 16 customers add this quarter, which is fewer customers. In terms of total dollar amounts, they were similar with the prior quarter. It sounds to me like maybe the new transactions are getting a little bit -- maybe getting a little bit larger? At least they were in the June quarter. Do you expect that to continue? Or is that how the quarter broke out?

As you know, Rich, a lot of our quarters -- our quarters are pretty smooth in the aggregate, but when you start to slice them into pieces, some times they get variable. That's kind of what happened with new customers this quarter. We have, however, seen a trend toward larger deals. It certainly is something that we're trying to emphasize, both with new customers and with repeat business from existing customers. Part of our strategy to provide more functionality and more products, like Flow Recorder, is to broaden the sale. When we both deal with existing customers. I don't think you can point to this quarter as being solely a proof point of that. It is certainly the trend that it indicates is the trend we're pushing.

Does the sales cycle lengthen there? Or is it just that the deal sizes are creeping and they are not substantially larger?

I didn't understand the sales cycle?

With larger transactions, are the sales cycles getting longer? Is it taking longer to close the deals? Or is it such that the deals are getting slightly larger? It is not like they are getting incredibly larger in which case we would see the sales cycle lengthening.

It is the latter. They are not lengthening. And we're not seeing a quantum jump in deal size. It is a creep in deal size. And we actually aren't seeing sales cycles lengthen, that hasn’t been a phenomenon.

Thank you.

Thank you, sir. Our next question comes from Eric Martinuzzi from Craig-Hallum. Please go ahead, sir.

Thank you. Was there a contribution on the revenue side from Quantiva in Q1 and do you expect it in Q2?

Eric, no there wasn't. We – well let me be more precise -- Quantiva had, before we acquired them -- a very, very small services business, and we have for a short period of time to accommodate those customers, continue that services business. So there is a very tiny revenue element from our services business, negligible from that services business. We are in the process, as Anil mentioned, of taking the Quantiva technology and integrating it with our broader solution. We're on track to produce the first NetScout products from that integration by year end. That's when you'll see the significant -- more significant revenue contributions starting.

That's fiscal year end? Or calendar year end.

The revenue will be more towards the fiscal year end.

Okay. And then the guidance for the 10% operating margins by fiscal year end, that also was an adjusted operating margin or was that a GAAP?

No, that's adjusted operating margin. To make it clear, when we first announced that a quarter ago, we were on a GAAP basis, because we hadn't yet made the Quantiva acquisition. So the GAAP numbers from -- that we talked about and projected for the operating margin from a quarter ago was GAAP equals adjusted, if you will.

Now that we have the Quantiva acquisition, we're excluding those, as you have seen, from the press release and the commentary. We're excluding those Quantiva expenses. It is on that basis, which is essentially equivalent to the same basis that we talked about a month ago. We're talking about the 10% operating margin.

The SOX compliance -- first of all, congratulations on achieving it.

Thank you.

Second of all, what is there ongoing -- I know there is a somewhat seasonal aspect, where there are more consultants in that maybe required on the accounting side. How should we model this on a fiscal year basis? Do you see it bigger in Q4 or Q1 on the G&A side? Should we just take what you've posted in the June quarter as a runrate on G&A?

I think there are two components of it. You pointed out one of them. Which is the additional help that we require. To the extent that that is part of the estimate that Price Waterhouse has provided us for their audit, that's in our runrate numbers now. So you can just model that going forward.

To the extent that we require additional outside help, as we did last year, to come in and help us with our own testing, we may end up with a slightly higher expense number. But we are accruing for that eventually as well. We also have an internal number, internal head count that we have added, as we talked about last year. Those people are on board. We're not planning on adding more people for Sarbanes compliance this year. So I guess the short answer is most of what we expect is already in the runrate.

And then lastly on your partners, you mentioned a couple of biggies, IBM and HP. There are other players within network infrastructure that would matter. I mean BMC, Compuware come to mind, as far as the software that people use to run their networks. Is there any plan in place to penetrate those other providers on a more meaningful basis? Or are you happy with what you've got with IBM and HP?

We're talking about looking at all of the potential partners in the space. Really our comment was based on -- focused on HP, and IBM based on two things. First, they are sort of the thought leaders in the space that is the integrated management of heterogeneous infrastructure in an autonomic, on-demand or adaptive way. They are sort of the poster children for that trend that we believe we support very well. Secondly, when we acquired Quantiva. Quantiva already had burgeoning relationships with those two companies. So we are continuing to work those relationships that Quantiva was establishing. So that's the reason we focus on those. But, we think, in general, across the marketplace with players who are trying to provide better management of heterogeneous infrastructure, we have value to add to many of their solutions. Compuware of course just bought Concord Communications.

Sorry, CA. Thank you. Excuse me. Wrong one. Excuse me, CA just bought Concord Communications. And they, perhaps, as a desire to help move their product line forward. Certainly, we would expect that was part of their motivation. Therefore, they may be less interested in partnering with us at this point. And everyone has a potential partner, has their own particular posture in that regard. So we don't mean to exclude anyone from our universe, but just point out our focus.

I think the key thing is, we are talking to many players, including some of the ones you mentioned. We have traction with HP and IBM. They happen to be the bigger players.

I would assume they are the ones your financial services customers -- for instance, most use one or the other.

Yes. Most of the customers use one or the other. Most of our current customers use either HP or IBM -- at their umbrella management systems.

Okay, then last question. On a licensing royalty, it's still -- it hasn't gone down to zero and on a pre-tax basis, it amounts to about a half a penny a share. It is still coming in in dribs and drabs here? What is your expectation for September on that?

It should be zero. This is the end of the line. I mean, we've been talking about the Cisco relationship, the resell relationship of our software winding down. That is accomplished. This will be the last quarter of royalties.

Thank you.

Thank you.

Thank you, sir. [Operator Instructions] Our next question comes from Dave.

Hi, guys. This is actually Jason Crawshaw from Brait in for Dave.

Okay.

Hi, a couple of questions. I think in the last conference call, you referenced some of the changes and the competitive environment in the space with all of the M&A. It sounds as if there is competitive disarray. Is that still the case? It sound like there was an opportunity to exploit some of that. Is that still the case? Would you still characterize it in that regard?

We don't see any big change from the last time in that environment. I think it will smooth out moving forward, but I think the same thing is still valid.

Okay. It sounds as if linearity in the quarter was pretty good. Is that a fair assessment?

Yes, it is. Very linear in the quarter.

And as far as overall end market demand visibility, is that about the same as last quarter? Has it improved at all? How would you characterize the end market visibility for you guys?

Well, I think in general our visibility is pretty good. About as good as last quarter. I'll point out to you, as we did before, that the visibility comes in a couple of pieces. One, we carry a small backlog that goes up and down. We don't disclose the amount of that. We have orders that are sort of in process, but not yet in the backlog. Again, we don't disclose the amount of that. We have a pipeline, a sales pipeline that is orders still to come -- that we scrub pretty hard for the upcoming quarter. The combination of all of those represents our visibility. In the aggregate, I think our visibility is probably about the same as last quarter, which was pretty good.

Great. And then just lastly, you know, any further thoughts to use of cash. There is a lot of cash on the balance sheet. Last quarter any sort of further commentary on cash usage?

We don't have any specific plans for cash that we can disclose. And I don't mean to be coy about that either. Our cash, obviously, we have more cash than we need for operating purposes. We are still generating cash. We have made acquisitions in using cash recently. And we may do so again. But nothing we can disclose.

Thanks, guys and good job.

Thank you, Jim.

Thanks you, sir. Our next question comes from Jeffrey Meyers from Intrepid Capital.

Thanks a lot guys. Maybe you could talk a little more about the wireless service provider business that you saw in the quarter. You know, maybe a little bit about who the competitors are in that space, and what sort of value you guys are adding, versus some of the different competitors there.

I think that overall the the wireless service provider is a different vertical for us but it has the same requirement as other verticals like financial services. Wireless service providers have more money and more budgets to spend and they are just emerging users of what other people have been using our product for. The competitive environment is the same as with other customers. And the advantages are the same as we spoke last time as well as this time. It is differentiating technology in the form of CDM, High-Definition, High-Definition being, we can really pinpoint and recognize all the services. And in the case of wireless service providers we can identify wireless users, the services, and differentiate one from another in terms of performance and network usage.

So you aren't seeing let's say Micromuse or Infovista now more than you would in the enterprise?

Wireless service providers in some sense -- we are really being used not as a service but on their internal network. In that sense, they are more like an enterprise customer – so we don’t really see Micromuse or Infovista more just because we are dealing with wireless service providers.

Okay. Thank you.

Thank you, sir. [Operator Instructions] Sir, I'm showing no further questions in the queue. I would like to turn the queue back to you for any concluding remarks or comments.

Thank you very much. Thank you for attending our conference. We appreciate your interest and your questions. And we look forward to speaking with you again at our next conference call in three months. Thank you.

Ladies and gentlemen, this conference will be available for replay after 8:00 p.m. eastern standard today through August 10, 2005. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 789837. International participants dial 320-365-3844. Those numbers again are 1-800-475-6701. and 320-365-3844. Access code 789837. That does conclude our conference for today. Thank you for your participation and using AT&T executive teleconference.