Netscout Systems Inc (NTCT) 2007 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to NetScout's first-quarter fiscal year 2007 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'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 now like to turn the call over to Mr. Singhal. Please go ahead, sir.

Thank you and good afternoon, everyone. Welcome to NetScout's first-quarter fiscal year 2007 conference call for the period ended June 30th. Our call today will begin with a brief overview of our financial developments achieved this quarter followed by a summary of our operating highlights for the recent quarter. Later, David will review our financial results and the company performance in greater detail. At the conclusion, there will be an opportunity for questions and answers. First, Cathy Taylor, our Director or 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 these forward-looking statements may involve judgment 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 and market acceptance of the 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 our projections not to be achieved include the specific risks and uncertainties that are discussed in NetScout's Form 10-K for the year ended March 31, 2006, on file with the Securities and Exchange Commission. And with that, I will now turn the call back over to Anil Singhal, our Chief Executive Officer.

Thank you, Cathy. Our financial results for the first quarter of fiscal 2007 were a disappointment following a string of 11 quarters of sequential revenue growth and strong fundamental execution on all fronts. Our first fiscal quarter ending in June is historically a weak quarter for us and despite our focus on mitigating the seasonality, the normal downturn was stronger than we expected and we saw seasonal softness across the Company. In Europe, the seasonality was amplified by the sales team restructuring that we initiated last year. Based on our review of our first-quarter performance and expectations for the remainder of the year, we believe these issues will not carry forward into the rest of the fiscal year.

Our view of NetScout's long-range prospects is unchanged and we believe that the underlying drivers of our growth remain strong despite the first quarter weakness. For these reasons, we remain comfortable with an annual EPS growth target for fiscal 2007 and 2008 in excess of 40%.

In addition, we are announcing today an expansion of our stock repurchase program as a result of the confidence that we have in our business and our commitment to maximize shareholder value. We also believe this is a good use of our substantial cash resources to help realize that value while still providing cash for potential acquisitions. NetScout remains strongly cash flow positive and we expect to increase our cash flow going forward. In terms of details, we will be increasing the authorization to purchase up to 3 million additional shares of NetScout's stock on top of the 850,000 shares that we have already authorized for repurchase. This stock repurchase program now represents approximately 11% of the current fully diluted shares outstanding.

We intend to execute the buyback very diligently in order to maximize shareholder value and to support the growth of earnings per share and return on equity. Our confidence in our growth prospects and our ability to execute is based on our track record over the last three years and several other factors which I shared with you during our last quarter call. These positive factors and fundamentals remain unchanged as we enter our second quarter.

First, there is an increasing market recognition of the value of our approach to application performance management to address the growing IT challenges of VoIP deployment and Service Oriented Architecture application design. The continuing attention of the larger players in the enterprise management system space is testimony to that trend. Yesterday, Hewlett-Packard announced the acquisition of Mercury Interactive. With have a good relationship with both companies that we believe will be further enhanced by the combination.

Second, our technology leadership and the flow of market leading new products is distancing us further from the competition. During this quarter, we began shipping our nGenius Analytics and our nGenius Application Fabric Monitor based upon our next generation Application Fabric Performance Management architecture. These products are market leading solutions that proactively identify and resolve performance problems faster and assure business service reliability in increasingly complex high-speed networks. The nGenius Analytics product adds intelligent early warning capabilities to our solution set and is based on a sophisticated behavior modeling technology, for which we have recently been granted a U.S. patent. The nGenius Application Fabric Monitor represents a new class of instrumentation, combining the capabilities of our nGenius Probe and nGenius Flow Recorder products in a single high-capacity and high-performance platform that puts us in a superior cost-to-capability position versus our key competitors.

Third, we demonstrated our success in attracting new enterprise customers this quarter, adding significant names such as ATI Technologies, Bank of China, and Mittal Steel in Poland. We had nine deals with existing customers each with earning over $500,000, including four customers from financial services, one from government, health-care and manufacturing.

Fourth, we continue to add wireless carriers to our customer base and did new business with existing carrier customers. We added five new wireless carrier customers this quarter, including Comcast Cable. The last two of the nine deals over $500,000 came from existing wireless carrier customers.

As part of our growth strategy and to capitalize on these opportunities, we committed to growing our direct sales force significantly in fiscal 2007. Through the end of June, we have added nine salespeople, bringing our total to 55. We expect these new people to begin making an impact on our revenue growth in the second half of the year. We believe that this investment in our sales organization is a strong indicator of our confidence in our market opportunity, competitive position and commitment to drive revenue growth and gain market share.

In summary, we are confident in our future and we believe the first-quarter revenue shortfall was not the result of increasing competitive pressure or the weakening in demand of our products. We are optimistic that our strong product leadership position will enable us to reach our long-range growth targets while continuing to expand operating margins. We look forward to sharing our achievement of these milestones with you in the upcoming quarters. 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.

Our first-quarter revenue of $23.6 million was flat year-over-year and down 9% compared to revenue of $25.8 million in the previous quarter. Net income from the quarter on a GAAP basis was $1.4 million or $0.04 per diluted share compared to a net income of $1.8 million or $0.06 per diluted share for the previous quarter and compared to net income of $652,000 or $0.02 per diluted share in the first quarter of fiscal 2006. Revenue contribution from our direct sales force was about flat at 41% compared to 40% last quarter. Reseller revenue made up the balance.

During this quarter, we added 32 new customers worldwide or 10% of total orders. The rest of our order volume came from 261 repeat customers. Forty-seven customers gave us orders over $100,000 this quarter, including two customers with orders over $1 million. Revenue from international sales was 16% of total revenue, down from 20% last quarter with Asia representing 6 points and Europe 10 points of the total.

In our vertical markets this quarter, financial services sector represented a 35% of order volume followed by government and telecommunications, each representing 16% of orders. The health-care, manufacturing, consumer sectors followed each with 6 to 10% of order volume.

During the quarter, we saw continued strength in competitive wins involving 22 deals totaling approximately $4.6 million. The majority of these deals involved wins against Network General.

Turning back to our financial picture, our gross profit for the quarter was $18.5 million, up 5% year-over-year and down 6% sequentially. Gross margin was 78% in the quarter, an increase of 3 points year-over-year and up 2 points sequentially and above our gross margin target range of 73 to 76%, due principally to the strength of our service business, which reached a record $9.3 million in the quarter.

Operating expenses in total were $17.4 million, up 1% year-over-year and down 1% from last quarter as we continued strong expense controls. Income from operations was $1.1 million, which included $387,000 of stock-based compensation expense and $143,000 of amortization of intangible assets from the acquisition of Quantiva.

Operating margin was 4% for the quarter, up 2 points from last year versus our recently revised long-term operating model of 15 to 20%.

Turning now to key balance sheet measures, cash and marketable securities are $90.8 million, an increase of $3.3 million over last quarter. Year-over-year cash increased by $13.5 million. Accounts Receivable net of allowances were $15 million compared to $16.8 million last quarter and $11.1 million a year ago.

Days sales outstanding were 58 days for the quarter, no change from prior quarter and above our target range of 45 to 55 days. Inventories were $4.4 million, up from $2.8 million in the prior quarter.

And now for guidance. We are issuing detailed guidance only for the September quarter today. We expect second-quarter revenue to be in the range of 25 to $26 million. We expect net income per share on a GAAP basis to be in the range of $0.05 to $0.06. In addition, we expect net income per diluted share to grow by at least 40% annually in the fiscal years 2007 and 2008.

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. Jody, would you go ahead, please.

(OPERATOR INSTRUCTIONS). Peter Jacobson, Kaufman Brothers.

You discussed, I believe you added nine direct salespeople in the first half, bringing the total to 55; is that correct?

Yes, that's correct, Peter. Nine people in the June quarter.

And what's the plan direct sales hiring for the second half of the year?

We plan to continue hiring, not quite at the same pace. We will add a handful of additional salespeople.

Okay. So the time to get those people up and running, given that you indicated they should start bringing revenue in the second half, is that like a sixth month timeframe to get them up to speed?

Peter, it's a six to nine month cycle, so we'll see some impact in Q3 and more so in Q4.

Okay. And with respect to softness in Europe, is there any more granularity available in terms of was that due to perhaps a general slowdown in IT spending or were there just delays in decision making or were there execution issues?

Let me maybe give you a point or two on that and then David can add other commentary. We don't see at least so far a delay or issue with economic spending. And, yes, there were obviously delayed deals, which is a combination of distractions and maybe some execution issues, which as we mentioned in the call, in the script, are somewhat temporary. So somewhere like seasonal Q1 issues, and there were other changes and we mentioned we did some restructuring there and so altogether they resulted in the softness.

So those changes are behind you now?

Yes.

Okay. And could you give a little bit more on your perspective relative to Hewlett-Packard and Mercury Interactive, just kind of reviewing how did you enhance your Mercury Interactive relationship recently? And I guess what are the implications as far as perhaps jump-starting a more significant relationship with Hewlett-Packard, which I believe was part of your strategic plan before that was announced?

Yes, basically we have -- Peter, we have announced partnership agreements with both Mercury and H.P. in the past. And we were attractive to these companies for different reasons. It was Mercury, it was more of our networking expertise and for H.P., it was the overall application performance management solution and architecture when integrated with H.P. OpenView.

So we think those things still hold true and hopefully it will help us take the relationship further. But for the short term, it's going to actually delay some of the things we're planning to do to sort out what we need to do together. So while I think a little bit longer term, it's a very (technical difficulty), it will have some short-term delays. What we're trying to do with them is the next step.

Eric Martinuzzi, Craig-Hallum.

Thank you, a couple of questions. The vertical strength, you talked about the wireless area being an area of strength for you. But given the performance here in Q1, I have to wonder if there is other verticals that have just disappointed. Because if all else equal and other verticals that remain flat, we should see some incremental benefit. Can you give me any insights there?

That's a good observation, Eric. In general, we saw, as Anil said, softness across the Company. And we believe that was more to do with our own Q1 seasonality, beginning of the fiscal year start-up issues than to do with a particular -- the strength of weakness of a particular vertical. So that applies with the issues in Europe as well. So I don't think -- I mean I think you see the verticals mix that we talked about in this quarter not all that different from the vertical mix we talked about in the past. Point here or there. But this issue wasn't strength or weakness of the wireless sector versus other verticals at all.

The services revenues were up nicely sequentially. What's the trend expectation there? Should that continue to grow throughout the fiscal year?

Well, we expect that it will. The pace of that growth is to be determined. But we expect that it will. You may recall that we had talked briefly in prior calls about an end of life cycle with some of our probe products that we have been going through for the last 18 months or so that had depressed maintenance revenue growth from earlier rates, and that we expected this year, fiscal '07, to be essentially through that cycle and to have the growth rate of our service revenue return to some more normal historical rates of low double digits and it has done that. And so we expect that that positive trend will continue.

On the sales and marketing line, we saw a sequential uptick. I understand that you have done some hiring but is there anything else in that line that would explain the increase in sales and marketing given the decline in product sales versus the March quarter?

Well, it is hiring; it is incentives for the sales force and significant activity of the sales force to get out and reach customers and that's sort of reflected in sales travel expense. And in general, it is a reflection of our investment in the future and developing customer relationships and bringing in deals in the near future that we think will fuel our growth. So it's really those things. There's nothing else besides direct sales -- selling activity that caused that growth.

I will say that in our first quarter and part of the issue of the startup in the first quarter, we have onetime sales activities, annual sales activities, like the sales meeting. We bring all our salespeople together at the beginning of the quarter. And we have our recognition events for high performing salespeople in the first quarter and those things do drive sales expense up sequentially in the quarter, but that's sort of all the normal first-quarter startup stuff.

Okay. And lastly I know I am two questions over the two questions I said I would ask, but the buyback, while I understand you don't really get credit for the cash on the balance sheet, you guys have historically had a liquidity issue and open market purchases by the Company would not help that. How are you proposing to go about this? Is there any chance we see maybe the Company doing something with insiders?

We don't expect any direct purchases from insiders, no. We will be in the market. We will be judiciously in the market. We think that our liquidity has been significantly better over the last four or five, six months. Our volume has been up. We think there's enough volume and interest in the stock at today's levels to afford this kind of buyback. It will take us awhile to execute because there are SEC imposed trading limits on the amount of buying that we can do. So no one should misunderstand or think that we are going to be in the market and immediately buying significant volume of that 3 million shares. We will be in the market promptly but we will be subject to the normal SEC restrictions. So it will take us awhile.

Jeffrey Meyers, Intrepid Capital.

Hey, guys. I just want to say congratulations on the buyback. I think it's a great idea and I sure you guys will deal with all the trading issues that are there. But I think it's going to be an accretive movement. So that's great.

I'm curious I guess about sort of when you look forward, you're thinking about snapping back to levels of last quarter and are there -- what are you seeing? I mean is your pipeline kind of unchanged to where it was last quarter or even better or were there deals that slipped last quarter that you're going to close early this quarter and maybe the linearity will be better than usual or maybe you can just comment on that?

Sure. Obviously, we didn't close some of the deals that we expected to close last quarter and those have moved forward. For the most part, as I think we said earlier, they haven't gone away but they're still to be worked. So we have pretty good visibility going into this quarter because of that. But of course the problem is that there is a finite amount of work that can be done by the sales force in any quarter. And so as those deals moved in from the first quarter into the second quarter and became top priorities for execution in the second quarter, some other deals that would've been invested at the time had time invested in them from will get less time and therefore may move out of the quarter. So you shouldn't assume that whatever rolled out of Q1 is automatically in addition to Q2. And I think you see that in our guidance for Q2.

Right. Is the mix between product and services going to go back the way it was last quarter and last year? Or is it going to be more towards services going forward?

I think you can think about it -- our service business is a pretty steady gradually growing business, based on incremental product sales, so you can think about our service revenue as reasonably steady and the thing that is more volatile is the new product portion of our revenue. And so, as revenue increases, the thing that will drive that is new product and you'll see a stronger new product mix and a less strong, therefore, service mix. Not because service is going down but because service is remaining relatively stable, growing but stable as product accelerates again.

Last question is just on the competitive front. Obviously, you see Network General a lot. But how about some of the kind of WAN optimization guys? I know Packeteer has talked about their abilities in kind of the visibility area. And that's basically getting more competitive so there are more of those guys out there. So how does that impact you competitively?

I think with the WAN acceleration players come back into our space when they find that they're facing challenges in the acceleration space. So they look for additional opportunities like companies like Packeteer look at additional opportunities in our space, which is more driven by monitoring. But we don't see that much competition there because when you compare apples to apples and look at some new products we are releasing Application Fabric Monitor. They have 10 times more functionality in terms of monitoring and visibility than any other WAN acceleration players because it was not designed to do that. So while Packeteer or other companies may list us as one of their competitors, that's very rare here. And most of the time when it does happen, we win because our product is designed for that application.

(OPERATOR INSTRUCTIONS). Brian Horey, Aurelian Management.

I was wondering if you could maybe just expand a little bit on the slow start to the year. It doesn't sound like it was concentrated in any particular geography or vertical. I mean is that --

Could you speak a little louder, please?

Sure, I was wondering if you could just maybe expand a little bit on the slow start to the year. It does not seem to be concentrated in any particular vertical or geographic area. And so I guess the question is, is this -- effectively are you saying that you cleaned out the pipe in Q4 and there wasn't a lot of pipeline to be harvested in Q1?

Brian, this is David Sommers. Yes, there was some element of that. It is a natural dynamic in our business that causes Q1's to be weak seasonally that there's a big push to the end of the quota year for all of the good, positive reasons and then we have these startup events for the sales force and new quotas set and all of that kind of activity going on, which happens in the first quarter. And that causes people to get off to a slower start. And that happens every first quarter.

This first quarter, it was a little more pronounced than we had expected. And it was, as you observed, across the board. So we are confident that it's nothing more than that and not, as you said, not an indication of any fundamental change in our competitiveness, market position, demand for products, etc. Is that helpful?

I guess. So do you think this was primarily a sales management issue?

Not really a management problem. I think it was a problem that we all felt that was -- we had a good handle on and it turned out that we didn't have as good an appreciation for what this first quarter's distractions were going to cause. And I mean I think that it's broader than just sales management. But, yes, I think it's fair to say we thought at the beginning of the quarter we were going to execute better then we did and the major reason we think is what I have explained.

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

Thank you all very much for coming to our earnings announcement and to our confirmation of our preliminary guidance that we issued early this July. We look forward to seeing you on our next earnings call toward the end of October. Thank you again.

Thank you. This concludes today's NetScout's first-quarter fiscal year 2007 operating results conference call. You may now disconnect.