Netscout Systems Inc (NTCT) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to NetScout's third quarter of fiscal year 2007 operating results conference call. (OPERATOR INSTRUCTIONS). 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, I will turn the call over to Ms. Taylor to provide the opening remarks. Ms. Taylor, please proceed.

Thank you, and good afternoon, everyone. Welcome to NetScout's third-quarter fiscal year 2007 conference call for the period ended December 31. In terms of the format of this call, Anil will begin with an overview of our third-quarter financial and operating results, and David will follow with a review of our finance results and company performance in greater detail. At the conclusion, there will be opportunity for questions and answers.

Before we begin, however, let me remind you that 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 and market acceptance of NetScout products. It should be clearly understood that the projections on which we base our guidance and our perception of the factors influencing those projections are highly likely to change over time. Although those projections and the factors influencing them will likely change, we will not necessarily inform you when they do.

Our Company policy is to provide guidance only at certain points in the year, such as during the quarterly earnings call. We do not plan to otherwise update that guidance. Actual results may differ materially from what we say today, and no one should assume later in the quarter that the comments we 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.

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

We are very pleased with our financial results for the third quarter, with revenue and earnings per share coming in at the high end of our guidance. Revenue was $26.5 million, 6% higher than the third quarter a year ago and also 6% higher sequentially. Product revenue was up 4% sequentially and service revenue was up 9%.

Last quarter, we expressed our confidence that the second half of the fiscal year would remain strong, and that confidence is being borne out. At the beginning of the fiscal year, we laid out strategic growth initiatives that we believe will produce a good foundation for future top-line growth and drive 40% earnings per share growth this year and next. These initiatives included an expanded sales team and territory coverage; competitive market share gains based on our new Application Flow Monitoring and Analytic products; and deeper penetration into the wireless service provider customer segment.

The strength of our third quarter is evidence that these initiatives are coming to fruition, and that we are executing on our business plan. We expect that our fourth quarter will be strong, and that we have laid the foundation for good growth throughout fiscal year 2008.

Our growth stems from our success at increasing the strategic importance of NetScout and of our nGenius solution to our customers. There is a clear demonstration of this in the larger new deals and repeat orders that we have seen.

During the quarter, we booked the largest number of deals -- over $500,000 in our history -- with 14 customer orders in that category. Of those 14, 4 were new customers -- also our largest number over $500,000 initial customer orders. Those 14 large orders included 6 over $1 million -- again, a record for us. These large deals were spread across our four strongest vertical markets -- wireless service providers, financial services, healthcare and government.

The majority of the deals came from repeat enterprise customers, who are seeing significant value and ROI from early deployment of our products. Their expanding use of nGenius is the result of the success of our strategy of staying close to our customers, responding nimbly to their changing and growing needs, and partnering with them to improve the performance of the overall infrastructure in delivering critical business services.

We are continuing to grow the number of our strategic large customer partnerships, and they are contributing increasingly to our growth. One of our new large deals this quarter came from a very large service provider in the U.S. This is a carrier that we have been working with for over a year to demonstrate the value of our nGenius solution in managing delivery of their new dramatically-expanding portfolio of IP-based revenue generating applications.

While the move to packet-based services is a disruptive technology for some legacy service providers, it is a double-digit growth opportunity for NetScout, where we have built a niche and differentiated core technology through our successful enterprise business. Over the past year, we have launched an initiative directly targeted at this market. We have been working with some of the world's largest service providers, both current and prospective customers, to make enhancements to our products in order to better support the implementation of the new IMS 3G network infrastructure, to meet the service and network challenges of moving to IP-based application delivery to their mobile customers.

Our products are now being deployed in a growing number of wireless carriers' revenue-generating networks, where they are monitoring such critical IP traffic to ensure high service delivery performance. We believe this market will provide a significant growth for us in fiscal year 2008 and beyond. Combined with the strength we are seeing across these other verticals, we are confident that we can achieve accelerated revenue growth.

On a different note, I would like to take this opportunity to recognize and thank my colleague and partner, Narendra Popat, who retired from his role as Chairman of the Board of Directors earlier this month. Narendra and I co-founded the Company in 1984, and we have worked side-by-side for over 22 years. Our partnership has been unique and strong, and our complementary skills and close cooperation have been one of the major reasons for NetScout's success today.

Starting from our humble beginnings in Narendra's basement office, we have worked for many years to build a successful company. Even though Narendra will no longer be involved in NetScout's day-to-day business, he will continue to work with NetScout, providing valuable council and advise on business initiatives and other important matters affecting the Company. His continued participation and counsel will help us on many fronts.

At the recommendation of our Board of Directors, I will be assuming the title of Chairman of the Board in addition to my CEO responsibilities. Jack Egan will remain Lead Director of the Board.

Both Narendra and I are very excited about the opportunities that lie ahead for us. We are deeply appreciative of the loyalty and support of our dedicated employees, customers and other stakeholders in building a unique culture and successful brand.

We will be giving you more insight into our goals for fiscal year 2008 in our next earnings call that is scheduled for the first week in May. With that, I would like to turn the call over to David.

Our quarterly financial results, which you can find in the financial statements, are included with our press release. Our third-quarter revenue of $26.5 million was up 6% year-over-year and over the previous quarter. Net income for the quarter on a GAAP basis was $2 million or $0.06 per diluted share, compared to net income of $2.3 million or $0.07 per diluted share for the previous quarter, and compared to net income of $1.9 million or $0.06 per diluted share in the third quarter of fiscal 2006.

Revenue contribution from direct customers was 39% compared to 37% last quarter. Reseller revenue made up the balance.

During this quarter, we added 36 new customers worldwide, or 21% of total orders. The rest of our order volume came from 290 repeat customers. 67 customers gave us orders over $100,000 this quarter, including the 14 customers with orders over $500,000 and 6 with orders over $1 million that Anil mentioned -- both records for us.

Revenue from international sales was 16% of total, down from 23% last quarter, with Asia representing 5 points and Europe 11 points. In our vertical markets this quarter, the financial services sector represented 39% of order volume followed by healthcare at 17% and telecommunications at 14%. Government and energy sectors followed, each representing 7 to 10% of order volume. During the quarter, we saw significant strength and competitive wins involving 22 deals, totaling approximately $5.6 million against Network General and a number of other competitors.

Turning back to our financial picture, our gross profit for the quarter was $20.6 million, up 8% year-over-year and 6% sequentially. Gross margin was 78% in the quarter, up 2 points year-over-year and 1 point sequentially.

Operating expenses in total were $18.6 million, up 11% year-over-year and 11% from last quarter. This increase was due principally to higher personnel expenses, principally from increased sales activity, including our successful 2006 User Forum, which resulted in higher travel and sales commissions.

Income from operations was $1.9 million, which included $357,000 of stock-based compensation expense and $143,000 of amortization of intangible assets from the acquisition of Quantiva. Operating margin was 7% for the third quarter, down 2 points from last year and down 3 points from last quarter. Our long-term operating margin goal remains 15 to 20%.

Turning now to key balance sheet measures, cash and marketable securities are $95.1 million, up $4.4 million sequentially and year-over-year increase of $17.8 million.

With respect to our share repurchase program during the quarter, we repurchased 53,000 shares. We expect to continue the execution of the buyback program going forward.

Accounts receivable net of allowances was $16.5 million compared to $17.9 million last quarter and $19 million a year ago. Day sales outstanding were 57 days for the quarter, down from 65 days in the prior quarter and slightly above our target range of 45 to 55 days. Inventories were $4.4 million, up slightly from $4.3 million in the prior quarter.

And now for our guidance. We are issuing detailed guidance only for the March quarter today. We expect fourth-quarter revenue to be in the range of $26.5 to $27.5 million. We expect net income per diluted share to be in the range of $0.04 to $0.05.

Included in forecasted net income per diluted share is a non-recurring charge of $0.03 per share relating to the retirement and advisory agreement for the Company's outgoing Founder and Chairman, Mr. Narendra Popat, which will have an operating margin impact in the fourth quarter of 5 points. Excluding that charge, we expect the fourth-quarter operating margin to be 12 to 13%. In addition, we expect annual net income per diluted share to grow by at least 40% annually in fiscal year 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 of this information, even though our expectations may change during the quarter.

And now, Anil and I will take your questions. Emily, would you go ahead, please?

(OPERATOR INSTRUCTIONS). Eric Martinuzzi, Craig-Hallum.

Congratulations on a successful quarter. My question has to do first of all with the guidance. You guys are talking about at the midpoint $27 million. And it looks like based on the EPS, the $0.25 that we would be doing, would be basically net of the Chairman charge, we would be at $0.24 to $0.25 for 2007. Is that correct?

That is approximately correct. I think you may find there ends up being some rounding in our EPS that might push us up to $0.01 on that EPS range, given the guidance that we have given. But yes.

So at the high end of that, we would be at 40% EPS growth versus '06. So I am just wondering what is it that causes the acceleration in 2008. You know what I mean? If we are talking about a 40% EPS growth, and we are just -- we are at about 38% EPS growth the year just ended. So could you elaborate?

On acceleration?

Yes.

Well, we are anticipating, Eric, an acceleration of the top line and 40% plus in EPS growth next year. That is really what we were referring to. I think as Anil said, our growth initiatives that we have started earlier this year have begun to kick in. But we expect higher than mid single-digit product revenue growth going forward.

Then that is where I'm struggling with. Because I've got -- for the past three quarters and then the quarter just guided to, we are still pretty much -- we are at 5% year-on-year growth forecast next quarter. We just put up a quarter with 6% year-on-year growth. Prior to that, it was 5%. I just -- what is it that you are seeing that I am not understanding here about how it accelerates to double digit?

Well, the first thing -- so I think there are two questions. You are saying, how are you going to do 40% EPS growth with the same top-line growth? So answer to that, David said, is we will have higher top-line growth next year.

The second question is, why do we think that is going to happen? And I think with the number of people we hired last year, which we mentioned takes more time, it takes some time -- 9 to 12 months -- for them to come up to speed; some new territories we have started working on from scratch; and the wireless service provider initiative combined with some of the new product announcements. They will all lead to -- hopefully -- to higher top-line growth. And that is the reason -- and we are defining the extent of the top-line growth with this minimum 40% EPS guidance in next year.

So is it fair to say that the success of December was still sort of your legacy, more tenured sales folks as opposed to the sales force additions that were done back in June?

Yes, I think there have been slight improvement, as you can see, that we had not only -- while 6% year-over-year growth was not that impressive, but 6% sequential was impressive. So the 6% -- part of that was related to some of the things already working.

But you are right. The major impact of these initiatives will be seen -- better impact of this will be seen in the coming quarters.

Peter Jacobson, Kaufman Brothers.

Real nice results, everyone. The 40% EPS growth, does that assume a higher mix of licenses?

As we drive revenue up, as Anil has talked about -- it's a higher revenue growth -- that will result in a higher product mix versus service than we have seen in the past in the December quarter, yes. Was that sufficient?

Yes. Going forward, I guess you -- how dependent are you on large deals? Do you expect the large deals to come down somewhat? Was this an unusual quarter for that (multiple speakers)?

Yes, it was higher than we have seen in the past. We have been driving to build strategic customer relationships to strengthen the partnerships we already have with customers and to drive the size of deals as we deliver more value. And that is part of the strategy that we think is working well, as Anil said.

So we will not, I think, see 14 deals regularly over $500,000 in a quarter. But as we get more and more -- a higher population regularly in the quarter, in quarters of that size deal, we become less dependent on them, on any one of them, right?

So our projections for Q4 and going forward do not depend upon getting any particular number of $1 million or $500,000 deals in a quarter. We have lots of, as we demonstrated I think in the numbers we gave you, lots of smaller deals that come in as well. So we think that the larger percentage of large deals is a very positive thing for us. It improves sales productivity and is an indication, as I said, of our customer relationship strength.

Then with -- you gave a pretty good description of the robust environment in the service provider area. How would you characterize the spending environment now and over the upcoming quarters to distinguish between enterprises and government and maybe general IT spending versus performance management or network management-related spending?

Overall, the spending has been quite good. I think wireless service provider -- I think that we have seen estimates of 5% or so for IT spending, roughly flat with last year overall. But since we are trying to build our business in the wireless service provider area and there are some key requirements we are filling in, that is why I think we are going to see better spend -- a higher spending on our product, even if the spending is at the lower level.

But overall, the general environment seems to be very good. I want to mention that we differentiate -- what we are turning to is more -- a more newer service provider, which we call wireless service providers, rather than the traditional service provider and telcos. So there, I think there is a great need as they deploy revenue producing services which can be accessed over your mobile phone. And if we are able to directly address some of the issues they are facing, then I think that is a good budget opportunity for us.

Then, are there any distinguishing characteristics with respect to enterprises and government? Again --

Well, to summarize, I think we did mention that earlier, but part of the bigger deals and some of the impact of last quarter was also end-of-year budget. So we don't confuse that with better IT spending.

But overall, I think environment is as good as before, maybe not better but as good as before.

Then, I think my last question, just on the partnerships that are in place. What are the key partnerships that are contributing to revenues today? And how is the pipeline for creating new partnerships going forward?

I think somewhere in the script, we had talked about partnerships. That time, we are talking about customers -- good customer partnerships with large customers, not about sort of OEM or traditional partnerships.

Second place, we talked about good reseller partnerships, especially as we are working with the service providers overseas. So those two are having good impact, and it is sort of bundling to our estimate.

The strategic partnership, which as you know, we have been trying to work with HP and other people, and we are still working on that. We are not expecting any big contribution in the near future. And the 40% EPS growth we are counting on next year is not dependent on being able to necessarily form any big, strategic partnerships.

Scott Zeller, Needham & Company.

I wanted to check on the six large deals over $1 million. Could you tell me, did you have any 10% customers in the quarter?

No.

Then, back to the previous -- or the earlier question around wireless service providers and the traction you've had there, could you give us a sense of domestically how penetrated you think that opportunity is versus the wireless service provider opportunity internationally?

In the U.S., I think that penetration can be defined in two ways. One is the number of customers we have and how deep we are into those accounts.

So in terms of -- since there are only a handful of wireless service providers in the U.S., we are more than 50% of -- we are exactly more than 50% of the customers right now. But in terms of how much we can do, I think we are at the very early stage.

And on the international side, we are just starting to build our channel and some of the new people we have hired. So there, we have a handful of service providers compared to the number of ones which are out there.

So overall, in U.S., we are -- we have been talking to most of the -- or more than 50% of the customers. But there is a lot of potential opportunities. In terms of the size of business we can do internationally, we have lot of scope in expanding beyond the handful we are working with right now.

It's interesting that you were mentioning the channel for international. You are not going to rely on direct sales efforts for that?

No. What I meant was generally and internationally, we have to work with partners. Traditionally, that is what I meant. I mean the -- we have partnerships in place anyway. So we are -- for going to the wireless service providers. So that work has already been done.

But that does not mean we have gone into all those areas. And especially, we didn't have people in some of these places. So some of the people we have hired in the last year are covering territories that we were not there.

(multiple speakers) then specifically on competition versus Network General, I know that you cited in your script the wins. But could you tell us with some granularity what it is that is helping you win those deals? Is it the technology or is it pricing? Could you give us some granularity?

On the pricing, it is not that much different. It is mostly technology and our approach, which is top-down, where we try to tell the customer who is troubleshooting a problem or doing capacity planning or reporting or anything they can do with our products, we have a different approach and we have a more solid technology platform. And those are the primary reasons.

I mean price is an issue here and there, but that is not the reason we are wining competitively.

Are you finding that they drop price in order to win?

Yes, I think sometimes, both sides have to do that. But like I said, price is not the reason why people are selecting our product.

How about the analytics uptake? Is that a differentiator in these deals?

Yes, it is a differentiator, even though we have started selling their product. I mean, that is part of our top-down approach. We have a three-level approach, and analytics is one of the levels.

[Samuel Saunders], [SIG].

Congratulations on the good quarter. I wanted to spend a little time on two verticals in particular. One is the government vertical. I think there has been a couple of negative surprises out of the system integrator space for government contracting, and I was wondering if you were seeing any visibility of that in your government pipeline.

We are really not seeing anything unusual acting one way or other. Right now, I think we have steady sales business, and I am not sure whether we are working with those system integrators.

Yes, our government business was reasonably strong in the December quarter from a seasonal perspective. Normally, the December quarter for us and our several years of government business has been weak, because it is the first quarter after the fiscal year -- the federal government fiscal year-end.

But we had reasonably good -- so I think from that basis, we did not -- we would not say we have seen weakness. Part of that is because we are pretty heavily concentrated in the military, still working hard on the civilian side. The military tends to be, even these days, tends to be less fiscal year driven. But having said that, we still had a very good quarter in December, I think, in the government space.

Could you tell me if you are working on any of the information security initiatives in the military?

We have a lot of certifications which allows us to qualify for certain bids, but we are not really necessarily working on any official initiative.

Then the second vertical I wanted to look at was the healthcare vertical. I am looking at your history, and it is not ones you normally highlight. So I was wondering if you could comment on the strength we saw there and whether that is sustainable.

1 of our very large deals, as Anil pointed out, was in the healthcare industry. We are -- have had increasing success with healthcare providers at establishing this kind of a partnership. And one of our very good partners was the source of much of this business in the December quarter for us.

The healthcare business is a growing opportunity for us, because of their increase in outsourcing. To the degree that large image files are sent across healthcare infrastructures along with other traffic, that increase is the criticality of performance of some of the delivery of those images and the resulting analysis. And so, we are seeing increased interest.

I mean, healthcare providers, depending on the part of the healthcare industry that you are focused on either may be investing or may not in network enhancements. So it is not as generally, I think, a positive or negative trend across healthcare.

But we are -- healthcare has always been a strong vertical for us, perhaps not as strong as this quarter, as you point out. But we are encouraged that the drives in healthcare to more -- more heavy dependence on networks and more critical dependence on networks is going to increase our opportunity there.

(OPERATOR INSTRUCTIONS). Alex Foster, Private Investor.

Congratulations again on your strong results. In regards to the higher sales and marketing expenses this quarter, is that entirely due to increased activity or does that reflect some continued sales force expansion?

Well, it is both. We have had some increase in sales expense -- sales and marketing expense this year from our hiring that we began at the beginning of the year. But the differential between our September second-quarter results and the December third-quarter results was principally activity driven, more travel to our User Forum -- as we explained -- and elsewhere and greater sales success, which because of our sales compensation plans, depending on the pattern of that success, can drive -- can accelerate commissions.

We have those sorts of -- normal sorts of incentive plans in place. So as we approach year-end and as we see what the pattern of success in some of our large deals with some of our salesman is that that can drive an increase to sales commissions. And that happened to us in December.

As you can probably deduce from our guidance on operating margins, we are expecting that margins are going to come back into line with our earlier announced expectations of -- at the top end of our range -- 13% operating margins for the fourth quarter, the March quarter. So we believe that much of that activity-driven expense surge is behind us in the third quarter.

Could you clarify the size of the field sales force compared to the previous quarter?

Sure. We have about 50-plus quota-carrying, relationship-managing salespeople, about 40 presales engineers, about 10 or a little bit less than 10 channel-focused people, and then associated support and management teams in the field.

The size of our direct quota-carrying, relationship-managing sales force is down slightly from where it was in the September quarter because of a couple departures. But that is a temporary phenomenon. We expect it to be back up to the -- higher than the target levels that we achieved in September -- at the end of this quarter or the beginning of our next fiscal year.

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

Thank you all for coming. We appreciate your interest in NetScout and your attendance at our conference call. We look forward to talking to you again at the end of our fourth quarter. Good evening.

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