Netscout Systems Inc (NTCT) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to NetScout's second 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. Instructions will be given at that time.

As a reminder this, conference call is being recorded. With us today is NetScout's President and Chief Executive officer 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. Kathy 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 second quarter fiscal year 2006 conference call for the period ended September 30th. Our call today will begin with a brief overview of our financial results achieved this quarter, followed by a summary of operating highlights for the recent quarter.

Later, David will review our financial results and company performance in greater detail. At the conclusion, there will be opportunity for questions and answers. First, let me introduce you to Cathy Taylor, our 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 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, the company's revenues, profitability and growth, and delivery of 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 make today are still valid. The risks and uncertainties that could cause projections not to be achieved include the specific risks and uncertainties discussed in NetScout's Form 10-Q for the quarter ended June 30, 2005 on file with the Securities and Exchange Commission. I will now turn the call back over to Anil Singhal, our Chief Executive Officer.

We just completed another successful quarter, making it our ninth quarter of sequential revenue growth with revenue up 15% year-over-year. In addition, product revenue was up 23% year-over-year. Revenue for the second quarter was $23.6 million, up slightly compared to revenue of $23.5 million in the previous quarter, and revenue of $20.5 million in the second quarter of last year.

Net profit for the quarter on a GAAP basis was $1.5 million, or $0.05 cents per diluted share compared to net profit of $652,000 or $0.02 cents per diluted share for the previous quarter and compared to a net profit of $1.1 million, or $0.03 cents per diluted share in the second quarter of fiscal year 2005. Last quarter, we began reporting earnings on an adjusted basis.

Adjusted net profit for the second quarter was $1.7 million, or $0.05 cents per diluted share, versus $945,000, or $0.03 cents per diluted share a quarter ago. Our revenue performance was within guidance, although at the low end of the range. We saw some slowing of order closures at the end of the quarter. However, order flow has been good so far this quarter, so we believe that slowdown was temporary.

In addition, we exceeded our guidance range on EPS as we contained operating expenses and grew our adjusted operating margin to 8.5%, up from 3.7% in the prior quarter. We are seeing the increased operating leverage that we predicted at the beginning of the year. We expect that we'll achieve our goal of 10% adjusted operating margins by the fourth quarter, even at the low end of the range of revenue growth goals we set at the beginning of the year.

The increasing interest in our continuously expanding product set was further validated by inputs and comments we received at our largest ever User Forum held during October in Cambridge, Massachusetts. This year, our event saw a record number of attendees and our User Forum membership has grown to nearly 1000 members. We had customers from around the world sharing best practices and meeting with NetScout executives and engineers to discuss more pressing trends impacting the performance of their business critical applications and network.

During the conference, we showcased our newly released High Definition Performance Management technology, new Flow Recorder products and nGenius Flow Collector. The key theme of this year's forum was centered on the challenges facing our customers and the early recognition of application and network performance problems and the need to shorten mean-time-to-repair.

We previewed our new Progressive Analytics technology based on the recent Quantiva acquisition, and our customers are already excited about the new products that will help them automate the process of detecting and diagnosing application as well as network performance problems before they impact critical business services. Our new analytics products will serve as an advanced early warning system, quickly detecting and diagnosing anomalies and finally determining qualified alarms with root cause. Our new analytics products are on schedule to enter beta testing before the end of the calendar year.

During the quarter we released a refreshed line of nGenius Flow Recorder products with added functionality and a series of new Workgroup Models. The Workgroup models are offered at a lower cost with the intention to broaden the adoption of these products for advanced trace analysis. Also during the quarter, we released a lower-priced Workgroup version of nGenius Performance Manager Software that provides the same level of functionality as the Enterprise Edition of nGenius Performance Manager, but scaled down to cover a smaller number of managed elements.

This Workgroup version is targeted towards enterprises or governmental agencies that require performance monitoring of regional offices where there are fewer network or application elements to monitor, or in places where business critical resources are in centrally focused locations. In summary, we are growing the number of products available to our customers, providing utmost in deployment flexibility, while still offering the lowest cost of ownership compared to our competition so that our customers can do more with less.

We are seeing the results of this strategy, evidenced by revenue growth and significant improvements in our operating margins compared to last year. We look forward to sharing with you more successes in the coming quarter. With that, I would like to turn the call over to David.

Thank you, Anil. It's 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, last quarter we began reporting our results not only on a GAAP basis, but also on an adjusted basis as a result of our 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, including the amortization of intangible assets and stock-based compensation. The expense amounts associated with these items are disclosed in parenthesis on the face of the GAAP income statement in our press release and 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 prospects for the future.

We use these adjusted financial measures internally for the purpose of analyzing and managing our business. I won't repeat Anil's discussion of our revenue and product revenue performance. Service revenue increased 10% year-over-year and increased 4% over last quarter. Revenue from our direct sales force was 35% compared to 39% last quarter.

Reseller revenue correspondingly, was 65% of total revenue compared to 61% last quarter due to growing strength in our reseller relationships. During this quarter we added 31 new customers worldwide, representing 13% of total orders. Among some of our largest new customers, are Exxon Mobil Upstream, HSBC Mexico, Department of Justice in California, Pharmerica, Saks Incorporated, Wellcare Health, and U.S. General Services Administration.

We had 254 repeat customers this is quarter, representing 87% of order volume. Some of our repeat customers include Lowes, Liberty Mutual, U.S. Agency for International Development, Cingular Wireless, Veterans Administration, Vodafone, Goldman Sachs, Defense Intelligence Agency, NASA, and Discover Financial Services.

We had 55 customers with order volume over $100,000 this quarter, including seven customers with orders greater than $500,000 and one customer over $1 million. Revenue from international sales was 18% of total revenue, down from 21% last quarter, with Asia representing 6 points of the total and Europe, 12 points. Turning now to our vertical markets, this quarter the financial services sector represented 37% of order dollar volume followed by a strong showing of the government sector with 20% of orders. Telecommunications, healthcare, and consumer sectors followed each representing 8% to 9% of order volume.

During the quarter we saw significant competitive wins, involving 20 deals, totaling approximately $2.8 million. The majority of the deals involved wins against Network General. One of these was a Fortune 20 company and new customer that had a significant Network General deployment for packet analysis that they were investigating upgrading.

Once they saw what our nGenius Solution could do, they selected nGenius not only for the analyzer upgrade, but for NetFlow and device monitoring, as well as application response analysis. Because they felt that nGenius provides a broader, superior functionality in a unified, scalable solution. This order is a pilot and a design win for a multidivisional deployment.

Another new customer is a large nationwide pharmaceutical company that was seeking to improve their application monitoring and packet analysis capabilities over their existing Network General implementation. This design win, which was our largest new order this quarter, almost $500,000, was also based on the integration and breadth of capability and depth of function of nGenius.

The credit card division of a large securities firm gave us a repeat business order for over $500,000, as part of their migration to a gigabit speed wide area network. Because of NetScout's demonstrated value in managing the application performance from the network vantage point, the customer has designed nGenius into their architecture for their important financial customer service and sales systems. The new high-definition probes, are replacing older, less capable NetScout probes that the customer has had installed for sometime.

Our million dollar order this quarter came from a national retailer, who is a repeat customer. The customer is using nGenius to monitor revenue and inventory management applications on their point of sale store network, as well as disaster recovery data transmission. The applications will be powered by a new 10 gigabit network core, monitored by our new 10 gigabit probes.

Turning back to our financial picture, our adjusted gross profit for the quarter was $18.3 million, up 18% year-over-year and up 3% sequentially. Adjusted gross profit is calculated by deducting non-cash expense of $105,000 of amortization expense from acquired software from the GAAP gross profit. Gross margin was 77% in the quarter, up 1 point year-over-year and up 2 points sequentially. And above our gross margin target of 73% to 76%.

The improvement in gross margin resulted principally from a higher than usual software component of our product revenue. We expect that gross margin will return to our target range in the future. Adjusted operating expenses in total were $16.3 million, up 11% year-over-year and down 3% from last quarter.

Expenses were down sequentially, principally because of lower sales and marketing personnel costs and reduced marketing programs. Adjusted operating expenses are calculated by deducting non-cash expense of $115,000 of stock-based compensation expense, and $39,000 of amortization of intangible assets from the GAAP operating expenses of $16.4 million. We also adjust out $8000 of tax effect of these non-cash adjustments.

Adjusted net profit for the quarter was $1.7 million, versus a net profit of $945,000 last quarter. Up from a profit of $1.1 million a year ago. Turning now to key balance sheet measures, cash and marketable securities are $77.5 million, an increase of $224,000 over last quarter. Year-over-year cash decreased by $739,000.

The decrease year-over-year is a result of the acquisition of Quantiva. Accounts receivable net of allowances were $12.2 million compared to $11.1 million last quarter and $9.7 million a year ago. Day sales outstanding were 47 days for the quarter, up from 43 days in the prior quarter and within our target range of 45 to 55 days. Inventory was $4.5 million, up from $3.1 million in the prior quarter, principally due to the slowdown of order flow at quarter end.

And now for our guidance. We're issuing detailed guidance only for the December quarter today. We expect third quarter revenue to be in the range of $24 to $25 million. We expect earnings per share on a GAAP basis to be in the range of $0.03 to $0.05 cents. On an adjusted basis, we expect earnings per share to be in the range of $0.04 to $0.06 cents.

In addition, we are reiterating our previous guidance of attaining 10% adjusted operating margin by the fourth quarter, and we expect fiscal year 2006 revenue to be at the low end of our 15% to 20% full year revenue growth target. 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 of this information, even though our expectations may change during the quarter. And now, Anil and I will take your questions. John would you go ahead, please.

Thank you. (OPERATOR INSTRUCTIONS) And first in line is Rich Sherman with Janney Montgomery Scott. Please, go ahead.

Good afternoon, gentlemen.

Good afternoon.

I got a couple questions here. Looks like you guys continue to manage your expenses very closely here. I notice that sales and marketing was down on a sequential basis. Is that sustainable? Was it higher in June than they had anticipated? And then it's coming back to a more normalized level, or do you think that sales and marketing will have to increase and it was just due to the lower product revenue this quarter?

Rich, the lower sales and marketing expense sequentially was due to some reduction in marketing programs, and due to some timing -- seasonal timing of events. We have a large sales meeting in the first quarter and we don't have a recurrence of that in the second quarter. But we are also, as you said, tightly controlling expense and we do expect that discretionary spending for the balance of the year will be under tight rein. Having said that, on those program side, as we grow revenue, of course, we will also grow sales expense. And we are continuing to add sales people as we have talked about earlier in the year. So net, sales and marketing expense will probably grow, but not -- but off of this lower base and not because of growth and discretionary spending.

Okay. Okay. And then the other standout, I guess, was the gross margin. From what I can tell, the product gross margin was a record at 71.5%. And you alluded to higher software in the mix. Can you give us more insight into that? I noticed that you mentioned device monitoring in one of your customer references. Are you sort of pursuing an independent strategy to sell the performance manager, absent the probes?

Well, I think David can maybe add something to this, but device monitoring and NetFlow monitoring, they are all included in the Performance Manager, so we just have one product for all the functions. And I think what David might be talking about is basically just the-- we sold more PM than probes this time, and that this mix goes up and down slightly.

There are fluctuations up and down in the mix as Anil suggests. And we had it where this is sort of the high point for us in that mix swing. We are seeing expanded deployments of performance manager and when we get a large expansion in a multi -- a master slave distributed deployment, then we will get a bubble. When we get an order like that we'll get a bubble in our software content. So that's really the driver of software. It's not as you have questioned. It's not really that we're going out and selling software only. We only really -- we sell PM only when we anticipate probe deployments and when we get a bubble like this. It's really because we have -- the customer's decided to do a significant order of multiple licenses. That's really what drives it.

Another thing is just one thing to add. This PM Workgroup which we announced a lower price margin, it's not just for smaller deployments, but it's also for additional deployment with a distinct PM. So that could have some effect on the software sales --

Going forward.

Okay, and on that Workgroup initiative, should we read into that that perhaps this is designed also to help with the indirect model? I certainly -- it certainly seems like the indirect sales peaked up here this quarter. Is this a response to channel sales requirements or is it just that you want to get in -- become more pervasive in the remote offices?

I think that's the primary reasons -- the two reasons that -- to -- for distributor deployment of larger customers, which is you can, to cut down the traffic on your network, you can deploy Workgroups at satellite site instead of all in central locations. And the second reason is to go where customers for lower -- lower price point. People who want to buy few probes rather than ten or twenty probes. So, if you want to go below $100,000 total sale, this makes it easier, especially in Asian countries like China and all those. Those are the primary, two big reasons for doing it. It may of helped in direct channel, but that's not the main reason.

Okay. Understood. And it looks like Goldman is back purchasing. Is that some product refresh on the probes, or is this Flow Recorder? Can you give us insights on that?

Well, I think -- I don't know that we -- they were always a big customer and so I mean they are using a mix of these. It's a mixture of service revenue, probes or Flow Recorder, nothing specific or different from before.

I'm sorry, but had Goldman already purchased Flow Recorder?

Yeah, there might be something in there, but it's not the main reason. It's mainly existing PM and probe deployment.

Okay, understood. And then lastly, you mentioned some maybe tightening toward the end of the quarter. Was there a specific geographic region where that phenomenon was experienced?

It really was not isolated. We did see more pronounced effect in the UK, but it was really a slowing across the board, which quite -- for which quite frankly it appears that there's -- it was an anomaly. We haven't, as we've said, seen a continuation of that. In the UK, we have had some turnover in our sales team. We've begun to rebuild the sales team and that impacted some of our performance in the UK.

David, can you give an idea when that head count turnover occurred? Was it during last quarter or was it in previous quarters --

It was really during last quarter, during the September quarter.

How pervasive was that?

We lost about half the team.

Okay. And you've replaced all of those?

No, we're still in the process. We've replaced the management, so, so that the process is well underway.

Okay. Thank you.

You're welcome.

Our next question's from the line of Eric Martinuzzi with Craig-Hallum Capital . Please go ahead.

Good afternoon. First, just a comment. It would be great if you guys could get the press release out a little bit sooner. It's tough to tear through things in seven minutes.

We apologize. We tried.

Okay.

It was a glitch, so it's not our practice, Eric.

Okay. Couple of questions. The strategic partnerships is one of the things you highlighted at your User Group meeting as an emphasis for, I assume, both the near and long-term. Have you made any progress and could you update us on those efforts?

Well, we have made some progress, but not ready to announce something and hopefully we can do that before the end of this fiscal year. And we did talk about earlier some progress we have made in the previous announcement in HP and IBM area in terms of integration with that product set. We talked about improved relationship and expanded relationship with SBC during the last call, but one or two other ones we are not ready to announce, but making some good progress.

Okay, and then just overall market growth, you guys are showing at least 15% growth here in fiscal 2006. Did the market grow substantial enough to support that sort of pace going forward, or should we look for a deceleration?

Well, I think -- if you're talking about expanding, I mean that's looking good right now. We are not seeing any fallback in that. So when we talk to our sales people, we don't see IT spending as one of the biggest issues. At the same time people are really looking at various options, and so I mean it's still challenging to do the deals. But I see the market -- there is enough demand for the kinds of things which we are doing.

Okay. Just because I know overall, large Capex expenditures are always under scrutiny, but certainly I would say it's probably high single digits for overall IT spending but you guys have shown almost double that with your current fiscal year. It just seems like there is either a share game -- you guys are taking share or the market growth is that --

Yeah, I think we'll see, as we talk about competitive things, we are taking some market share. And so you can say maybe some of that 15% is because of that.

Okay, and then lastly, bookkeeping item here. The interest income has shown fairly nicely here, in excess of $.5 million for both Q1 and Q2. What should we use for a run-rate for the interest rates here for the back half of the year?

Well, that's a good base, Eric. We are obviously -- we are an interest -- a price taker on interest rates, so if the Fed condition continues to push short-rates up, then you will see an improvement in that. We believe that there is a likelihood that they will continue to do that, and we're mostly short, so -- so the odds are it's going to be that high or a little higher. We don't, of course, plan our performance. We plan our performance as if interest rates are going to be flat. So we don't plan our performance or base our guidance upon that.

Okay. Thank you.

You're welcome.

Our next question's from Jonathan Rothenberg with Emancipation capital. Please go ahead.

Hi, guys.

Hi.

You mentioned that there was that slowdown -- just going back to the topic of a slowdown at the end of the quarter, and seeming -- seems like there's a recovery. Have you seen catch-up from the slowdown at the end of the quarter, or is it merely a resumption of activity you had been expecting, in which case, you know, that lost revenue is sort of gone, or is it sort of rolled into this quarter?

Well, excellent question, Jonathon. The slowdown -- the way this -- the way things work, we have sort of a set -- a number of sales guys out there who are working on these deals and when deals don't happen, order flow slows down for whatever reason, they continue working on them. We don't lose them typically, unless there is a budget issue with the customer where it crosses over a budget boundary. And that happened with the government this year, not that we lost any deals there, but typically we don't lose a deal. What happens is the sales people keep working on them and so those deals happen later, but then other deals that the sales force would have been working on, have the other deals happened earlier don't get worked on, so they tend to slide out. So it is sort of a sliding to the right effect. It's not as if we push the big boulder forward into next quarter and then the next quarter has this big pop.

Right.

There's so much capability -- closing capability sort of in the sales force to do that.

So basically the pipeline is enlarged by it?

The pipeline is enlarged, but the rate of closure may go down because we have, you know, because we have limited -- resources are limited to the number of people we've got. Was that helpful?

Yes. Thank you.

Okay.

And our next question's from Simon Wong with Pantheon. Please go ahead.

Hi, just a question. You mentioned that the guidance for a now fiscal '06 is in lower range of the 15% and 20%. Is that -- what is the rationale for indicating that it would be at the low end? Is it just because this quarter is a bit light and because the UK situation? Can you just talk through that?

Sure. Well, obviously we came in at the low end of our range for this quarter. And as we have looked out in the future, we are not, as we say, at the low end -- as we anticipate the low end of the 15% to 20% range, suggesting that we're going to be able to recoup the shortfall in the guidance or the low end of the guidance this quarter going forward, as I just answered the question from Jonathon. It's sort of once the -- it's not that the deals are lost, but the opportunity sort of moves to the right and pushes the whole -- the whole chain of events to the right. So we're just anticipating that instead of being in the middle of a range, we'll be at the low end of the range. That really doesn't speak to our view of our opportunity going forward at all. We think 15 to 20% growth is good in this market. We're very pleased with it and we think coming in at the low end of our target range is great and we will, as Anil said, be able to maintain our operating margin expansion at that rate.

Now, how are your new products doing? You are introducing a number of new products, including your recorders and [indiscernible] Quantiva acquisition. How are they being accept by customer base right now?

Well, first of all, we have a beta version of the Quantiva product and it has not been introduced yet, but other products, PM Workgroup group, are basically the same functionality as the PM and we just introduced them and we have seen good reception. And Flow Recorder is doing well that focus in the packet analyzer space where there is more competition than in the probe space, which is our mostly bread and butter business so far. At the same time, that's incremental business for us. So overall, I think all the new product introductions are doing well.

How significant do you think the new products would be in terms of adding to your revenue growth?

I think that's all bundled into the growth targets we have talked about. I mean the major portion of the revenue will still come from -- I mean we constantly -- our customers constantly add more instrumentation to their existing deployment and we continue to enhance our existing product at even a faster rate than some of the new products. So, it's very hard to just say that what is contributing. People make -- make a -- when they make a bigger sale by mix of product and it is a full effect from one product to another. So we think that our main product is still performance manager and probe, but having this additional product provide the flexibility for the customer to deploy in more places and to basically localize to a single vendor.

Right. You mentioned that you have won twenty designs from Network General, have you lost any to them?

Yes, we lose on occasion. Not as much as we win. As I think I may have said in a conference calls before, we also recognize, however, that our loss reporting is not quite as good as our win reporting because of human nature. So -- but based on what we know, we win a lot more than we lose and that's principally because of the breadth of our solution, versus our Network General competition and other competition. And so when our solution -- because it addresses more problems typically than they address, when customers see it and understand it, they -- even if that wasn't their design point, as we talked about one of these wins we had this quarter where they were really looking to upgrade their packet analysis capability and when they saw what we could do, not only packet analysis, but elsewhere, they expanded their, the scope of their, their vendor consideration to include everything we were looking at -- that we can do and we won easily. So sales guys not might think it was easy, but nonetheless, we won handily. So, we do lose. When the definition of what the customer's looking for, it tends to be narrower, and if it's just a specific limited function, which is maybe one of the many things we do, we -- the customer might choose a more limited solution than ours, but that's usually the main places where we lose.

Great. Thank you.

You're welcome.

(OPERATOR INSTRUCTIONS) And Mr. Singhal, there are no further questions in queue.

Well, thank you very much for joining us. We look forward to talking to you in 90 days about the end of our December quarter. We appreciate your attendance.

Ladies and gentlemen, this conference is available for replay. It starts today at 8:00 p.m. eastern. It will last until November 9th at midnight. You may access the replay at any time by dialing 1-800-475-6701, or 320-365-3844. The access code is 800464. Those numbers again, 1-800-475-6701, or 320-365-3844. The access code, 800464. That does conclude your conference for today. Thank you for your participation, and you may now disconnect.