Netscout Systems Inc (NTCT) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the NetScout’s fourth-quarter and fiscal year 2006 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 to you at that time. As a reminder, this conference call is being recorded.

With us today is NetScout 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.

Thank you and good afternoon, everyone. Welcome to NetScout's fourth-quarter fiscal year 2006 conference call for the period ended March 31st. We are very pleased to be reporting excellent results for our fourth quarter as well as the full fiscal year 2006. Today I will focus my discussion largely on our performance in fiscal year 2006, upcoming changes and opportunities in our marketplace and our strategy and prospects as we enter fiscal year 2007. Later David will provide more details on the fourth quarter as well as fiscal year performance. But first, Cathy Taylor, our Director of Investor Relations, 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 expressed our 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 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 by differ materially from what we state 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 the specific risks and uncertainties that are discussed in NetScout's Form 10-Q for the quarter ended December 31, 2005 on file with the Securities and Exchange Commission. I will now turn the call back over to Anil Singhal, our Chief Executive Officer.

Thank you, Cathy. As I mentioned in my opening remarks, we delivered good performance in the fourth quarter capping a successful fiscal year of superior execution on all fronts. In the fourth quarter our revenue was $25.8 million which came in at the top end of the guidance range. GAAP earnings per share were $0.06 which is at the top end of our guidance range.

This was the 11th quarter of sequential revenue growth for the Company. Annual revenue has reached $100 million run rate and 15% year-over-year. Product revenues, an even the better indicator of growth, were up 24% year-over-year. GAAP earnings per share was up 100% year-over-year reaching $0.18 for the full fiscal year and we hit the operating margin target one quarter ahead of the expectation we had set at the beginning of the fiscal year.

Fiscal year 2006 was a watershed year for our Company in many other ways as well. As we exceed the $100 million in revenue run rate of our strong business model we provide an opportunity to drive improving operating margin leverage and shareholder returns in the coming year. Our confidence is leading us to raise our long-term business model operating margin target to 15 to 20% on a GAAP basis. We believe that expanding operating margins will allow us to deliver annual earnings per share growth of 40 to 60% in each of the next two years.

David will provide more specific guidance for the first quarter and full fiscal year 2007. I would like to focus the rest of my discussion on our growth strategy and business model which will allow us to deliver on our earnings per share growth estimates. There are several important drivers of the growth. First and foremost, after several years of depressed IT spending in the post dotcom climate, there is an increasing recognition of the importance of management tools to address emerging IT challenges as organizations refresh, reengineer and expand their IT infrastructures and applications.

Last year we saw plenty of announcements from large infrastructure companies as well as enterprise management system vendors who are all trying to be the trusted adviser to the CIO through a renewed focus on management as they fight for a bigger share of CIO's increased IT budget. The acquisitions of a Micromuse, Concord, Visual Networks and SMARTS last year is another indicator of this renewed interest. This heightened potential will increase our market opportunity and also will make it possible for us to form strategic partnerships with some of the large players as they bring a unique perspective to the table with our compiling performance management solutions.

Second, in 2006 we began to see more of the benefits of our multi-year investment that began in 2001 in expanding our product and technology leadership in the market. During these five years we created and delivered our CDM architecture and successfully integrated the technology from our two acquisitions of NextPoint and Quantiva which have become now our flagship engineered performance management solution.

The patent-pending CDM technology allowed us to proactively collect, aggregate and monitor the most relevant application centric information to address critical performance problems. The NextPoint technology was then used to mine the CDM metrics for historical baseline reporting and service assurance purposes. Finally, the Quantiva technology will be used to mine the CDM metrics for automated analysis and fault management through dramatically reduced Mean-Time-To-Repair for IT operations.

The step in this five-year technology building process was a major innovation in the marketplace which significantly expanded our target market, installed base quality and competitiveness. This in turn has enabled us to drive a high rate of new product introductions. Our vision of managing application flows across infrastructure from network and application flow vantage points is now becoming mainstream and our nGenius solution is a clear market leader in that paradigm. Our customers are adopting nGenius as their architectural solution to manage increasingly complex distributor applications spanning across converged heterogeneous and widely distributed infrastructures.

In the days of the simpler, client/server architecture our solution was “good to have”. Now in the days of complex, Service Oriented Architecture base applications, our solution is becoming a “must have” particularly when those applications are mission critical. We can therefore expect to see larger deal sizes and higher average selling prices.

Third, throughout the last year the strength of our leadership was evident in our new customer base, many of them which came at the expense of some of our closest competitors like Network General. We grew our enterprise market share by adding marquis customers such as Exxon Mobil, Wal-Mart, Boeing, Ericsson and McAfee. We have continued to develop our government business with wins at the Securities and Exchange Commission, TSA and Homeland Security.

Fourth, we are seeing a migration of wireless carriers converting to IP-based and VoIP networks that are delivering revenue, delivering applications. This means that our application centric performance solution, which has been so popular for years with large enterprise customers, is becoming increasingly relevant to service providers and carriers in their quest to deliver high-quality services to their end-users.

Specifically wireless carriers have been adopting our product for their internal networks for some time and we continue to win new carrier customers with this approach like Telecom Italia, Telekom Austria and Virgin Mobile. We then work with them to expand their use of nGenius into their customer service network. We have had significant success with several major U.S. wireless carriers during the last year.

Fifth, we are in an excellent position to do more with our existing resources through the steady retention and growing experience of our workforce, the large R&D investment we have made over the last five years, and the reusability and expandability of our CDM technology to address emerging IT problems and challenges. This leverage of our existing resources is the basis of our expanding operating margin and our higher margin targets.

We are already leveraging the value of our core technology with our announcement we made earlier today at the Interop show in Las Vegas. We announced our new application fabric performance management architecture or AFPM, a new strategic architecture that is an extension of our market leading nGenius performance management system as well as our nGenius analytic solution. AFPM is designed to address the coming complex application environments in both enterprise and the carrier markets.

At the core of AFPM is the concept of pushing application behavioral analysis out from the central server site into the network that links the application infrastructure fabric. With our nGenius system based on real-time traffic sensors continuously monitoring application traffic across multi-vendor infrastructures. NetScout is uniquely able to drive such innovation in the industry. AFPM architecture will be the basis for the delivery of new powerful multifunction sensors and software products, including our newly patented progressive analytics technology. AFPM continues our history of market leading advances in application performance management.

In summary, fiscal year 2006 was a year in which we demonstrated the potential of our technology, products and market position. With our continued technology leadership and vision for application performance management that is now being validated by major players, our success in growing our enterprise market share and our inroads into the carrier market, we are extremely optimistic about our future growth and creation of shareholder value.

This is the foundation of our confidence in meeting our EPS growth targets of 40 to 60% in each of the next two years. The foresight and clarity of the vision that enabled us to stay the course during the years of slower growth and profitability is now being demonstrated in our performance and the movement of the marketplace toward our solution. We look forward to fiscal year 2007 and beyond with great anticipation. With that I would like to turn the call over to David.

Thank you, Anil. Our quarterly financial results, which you can find in the financial statements, are included with our press release. We're now reporting our results only on a GAAP basis and we will continue to report on a GAAP basis going forward.

In our fourth quarter revenue was $25.8 million, up from 4% compared to revenue of $24.9 million in the previous quarter and up 14% compared to revenue of $22.6 million in the fourth quarter of last year. Net income for the quarter on a GAAP basis was $1.8 million or $0.06 per diluted share compared to net income of $1.9 million or $0.06 per diluted share for the previous quarter and compared to net income of $610,000 or $0.02 per diluted share in the fourth quarter of fiscal 2005.

For the full year ended March 31, 2006 NetScout reported revenue of $97.9 million, reaching our goal of achieving a 15% increase over revenue of $85.2 million for fiscal 2005. Product revenue drove the overall growth with a 24% increase year-over-year. Net income for the fiscal year ended March 31, 2006 was $5.8 million or $0.18 per diluted share. We're pleased with these results compared to last fiscal year as we doubled net income of $2.9 million and $0.09 per diluted share from fiscal 2005.

Revenue from our direct sales force was 40% of the total compared to 42% last quarter. Reseller revenue correspondingly was 60%. During this quarter we added 39 new customers worldwide representing 14% of total orders. Among some of our largest new customers are Vodacom in South Africa, Bank of Montreal, Swedish Medical Center, BellSouth Telecommunications, Tiffany's and China Electric Power.

We had 265 repeat customers this quarter representing 86% of order volume. Some of our significant repeat customers include Cingular Wireless, Merrill Lynch, Discover Financial Services, the U.S. Air Force, Lowe's, VoiceStream Wireless, Continental Airlines, Key Mobile in the Netherlands, Vodafone, Bell Canada and Oracle.

We had 64 customers with order volume over $100,000 this quarter including three customers with order volume greater than $1 million. Revenue from international sales was 20% of total revenue, down from 22% last quarter, with Asia representing 5 points of the 20 and Europe 15.

Turning now to our vertical markets -- this quarter the financial services sector represented 34% of dollar order volume followed by the strongest quarter ever from the telecommunications sector with 23% of orders. Government, healthcare, energy and high-tech sectors followed each representing between 6 and 10% of order volume. During the quarter we saw continued strength in competitive wins involving 40 deals totaling approximately $6 million. The majority of the deals involve wins against Network General.

Turning back to our financial picture, our gross profit for the quarter was $19.5 million, up 16% year-over-year and 3% sequentially. Gross margin was 76% in the quarter, an increase of 2 points year-over-year and flat sequentially and within our gross margin target range of 73 to 76%. Operating expenses in total were $17.5 million, up 7% year-over-year and up 5% from last quarter. Income from operations was $2 million, which included $455,000 of stock-based compensation expense and $144,000 of amortization of intangible assets from the acquisition of Quantiva.

Operating margin was 8% for the quarter. This margin meets our previously announced fourth-quarter target of 10% operating margin on an adjusted or non-GAAP basis. This expansion of our operating margin is the initial installment on our commitment that we made to shareholders three years ago. As Anil said, we've reassessed our long-term business model in the light of our improving market position.

On a GAAP basis now we expect to be able to maintain gross profit margins in the range of 73 to 76%. We expect total operating expenses to range from 53 to 58% which is comprised of 14 to 16% in R&D, 32 to 35% in sales and marketing and 7 to 9% in G&A. We expect operating margins to reach at least 15% and we're targeting 20% on the high end of the range. We expect to continue operating margin expansion through fiscal 2007 and beyond.

Turning now to key balance sheet measures, cash and marketable securities are $87.5 million, an increase of $10.1 million over last quarter. Year-over-year cash increased by $3.6 million. Accounts receivable net of allowances were $16.8 million compared to $18.9 million last quarter and $11.9 million a year ago. Days sales outstanding were 58 days this quarter down from 70 days in the prior quarter and above our target range of 45 to 55 days. Inventories were $2.8 million, down from $4.1 million in the prior quarter.

And now for our guidance. We're issuing detailed guidance only for the June quarter today. We expect first-quarter revenue to be in the range of $25.5 to $26.5 million. We expect net income per share on a GAAP basis to be in the range of $0.05 to $0.06. Looking out a little further, we expect to reach 13% operating margin on a GAAP basis by the fourth quarter of fiscal 2007. In addition, we expect annual net income per diluted share to grow by 40 to 60%, as Anil indicated.

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 for this information, even though our expectations may change during the quarter. And now Anil and I will take your questions. Lisa, would you go ahead, please?

(OPERATOR INSTRUCTIONS). Peter Jacobson, Kaufman Brothers.

Good afternoon, everyone and good quarter. Just a first question. You mentioned Network General as your primary competitor. Can you expand a little bit more on the competitive environment characteristics in the recent quarter?

Yes, Peter, overall I think that there is not a big change in the competitive environment in the last quarter versus the last two years. But we face two kinds of competition. One is direct competition which is more like a similar product category --there are two solutions to basically the same problem with a similar type of solution and that's where we compete with Network General. And as time is passing by a bigger portion of our competition is coming from other management solutions as we access a bigger market size.

So even though we won a lot of deals against Network General, that was, as you saw, a fraction of the revenue we did last year. So Network General competition is more the product level competition, direct competition, but there is a lot of indirect competition for management budgets, IT budgets and we talked about how we'll have a better chance of accessing that through innovation and things we have been doing for the last couple of years. And in that environment in the past we have competed with all kinds of players like Concord and sometimes even compete with infrastructure vendor players. And so there's a big category of players that we compete with that is mostly indirect competition. Does that answer it?

Yes, thank you. You mentioned partnerships, are there any developments in terms of visibility to new partnerships?

I think we are making a lot of progress but nothing to announce yet. As you know, we already have partnerships at a certain level with HP and IBM and we have made some announcements that we'll make in that direction, but nothing big to announce yet. But we are seeing a lot of interest from major players.

Okay. And lastly, I think you described a relatively healthy IT spending environment. Do you see spending in performance management outpacing general IT expenditures or gaining a larger share of spending dollars?

I think first of all the visibility we provide to our products spans beyond performance management going into service assurance and even partly in the security space. So in that sense, yes, we see a bigger portion of the budget as assigned to us. But overall, based on what we've heard from the marketing analysts, overall IT spending is good for most of the networking and infrastructure companies also. We feel that the bigger part of the story is that IT spending will be quite good for the near future.

Okay. That's all I had. Thank you very much.

(OPERATOR INSTRUCTIONS). Matt Hewett, Craig-Hallum.

Congratulations on the good quarter, guys.

Thank you.

The first question, which industry -- it's kind of along that same line that you were just talking about -- which industries appear to be the most robust as you look out say the next 12 months for IT spending?

Basically we talked about our solution is applicable to almost all of our verticals and we see a lot of opportunities in wireless, government and financial sectors as always. But currently in terms of incremental increases the wireless sector seems to be the biggest.

Okay, great. And then my second question is given that your stock price is trading near the high end of its five-year range, do you see a material option exercise from your employee base in the near future?

We don't know for sure, but it's reasonable to project that there may be some employee option exercises in the coming quarter, as I said the stock has traded up as you're suggesting. We don't require our employees to notify us ahead of time.

I understand. That does it. Thank you so much.

Thank you.

James Cappello, Kern Capital.

My question is regarding the operating margin, it was down sequentially and I think it was down for two quarters in a row now. So I want to know how you expect to get the margin going beyond here?

It's not down for two quarters sequentially I believe you'll see. It is down this quarter as opposed to the third quarter and that is our normal seasonal impact of FICA and health benefits restarting that we talk about this time every year in our March quarter. We have a significant portion of the population -- employee population, that comes off of FICA at some point during the year. And so in our third quarter -- December quarter the employer portion of payroll taxes is decreased. And then in the fourth quarter -- the March quarter those come back and every January we also renew our -- as everyone typically does -- their healthcare plans.

And since employee expenses are a large portion of our costs and expenses, you see that impact, and that's really what caused the modest margin decline between the third quarter and the fourth quarter. I think it went from about -- it went down a point from 9 to 8. As we've indicated with our 13% target for fourth quarter of FY '07 operating margins, we expect to continue to grow margins as we did this last year by, as we did last year, by holding the line on resource growth except in direct revenue generating areas and therefore creating operating leverage as revenues grow.

So operating margin -- should that be up sequentially?

What time period are you talking about?

Between the March and June quarter?

Well, we haven't given specific operating margin guidance for the forthcoming quarter, just revenue and earnings. And only operating guidance for the end of the year. But obviously at some point during the year it's going to go up.

Right. I just wanted to get a feel for how that ramp would look in the kind of quarterly basis for this year.

Well, we haven't given that kind of detailed guidance out that far. I understand your interest, but we just haven't given that kind of guidance.

Okay. And can you talk a little bit more about the interest income, how that's going to ramp?

Our cash is invested conservatively and principally in short-term instruments that rise and fall with the short-term rates driven by the Fed. And as the Fed continues to drive rates up we get the benefit of that. And so you can sort of -- obviously we had an increase to our cash balance this last quarter which was very substantial and not sustainable at that level going forward. And that will obviously increase our interest income as well as any rate increases that come along.

But it's mostly been rate increase driven. Our cash has been reasonably stable over the last year because of the Quantiva acquisition. So we took it down in the first quarter of FY '06 to pay for the Quantiva assets and then it's been slowly ramping up, a big ramp in the fourth quarter. So you should expect to see some increase in our interest income going forward principally driven by rate increases which you can estimate.

Okay, thanks.

You're welcome.

(OPERATOR INSTRUCTIONS). Jeff Meyers, Intrepid Capital.

Just a question on the 23% business that came from Telecom. I guess what proportion of that is from wireless carriers? And then within that what portion of the wireless business is now going into customer facing networks as opposed to internal networks?

Well, Jeff, most of that -- I don't have a specific breakdown, but I can tell you that the bulk of that -- the vast majority of that was with wireless carriers. Mostly because wireless carriers are building out their businesses, expanding their businesses rapidly. And so whether it's on the internal side or the customer facing side, there's lots of opportunity there.

We have customer facing -- a significant customer facing business with principally one large customer now. But that large customer is providing a significant chunk of business for us. So of that 23% a significant proportion is from that one customer, not half, but a significant proportion.

And are you getting any indications from some of the other customers that they might also look to use you for customer facing?

It is one of our top priorities, to make that happen, and we're working on it at all of the major installations that we have on the internal network side. So, yes, we're very, very hopeful that that's going to follow.

Okay, great. Thanks, guys.

Thank you.

At this time there are no further questions. Are there any closing remarks?

Thank you very much for joining us on this call and for your interest in NetScout and our improving financial results. We'll look forward to seeing you on our Q1 conference call in July. Have a good evening.

This concludes today's conference. You may now disconnect.