Netscout Systems Inc (NTCT) 2008 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to NetScout's second quarter of fiscal year 2008 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 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 second quarter fiscal year 2008 conference call for the period ended September 30th. In terms of the format of this call, Anil will begin with an overview of our financial and operating results, and David will follow with a review of our financial 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 that 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 or implied statements regarding future economic and market conditions, the company's ability to integrate the Network General acquisition successfully, as well as other factors related to the acquisition generally; the company's revenues, profitability and growth, and delivery and market acceptance of NetScout products.

It should be clearly understood that the projections in 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 includes the specific risk and uncertainties that are discussed in NetScout's Form 10-K for the year ended March 31, 2007 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. We are pleased to be reporting another great quarter following a stronger-than-usual first quarter. We saw record second-quarter revenue, driven by strong bookings, with revenue coming in at $29.6 million, an increase of 18% year over year. We also saw another strong quarter of product revenue growth, growing at 20% year over year. On the bottom line, we saw improvement in our operating margin, which was 12% this quarter, up 2 points over last year and up 2 points sequentially. These results were consistent with the revised raised guidance we issued on September 20.

Our recent performance and good results demonstrate the success of the strategy we implemented last year when we made changes in our go-to-market strategy. Over a year ago, we expanded our sales force and positioned our sales efforts and product focus to address high-growth vertical market opportunities in the wireless, financial and government sectors. Today, we are seeing the results of these efforts in the strength and quality of our pipeline.

This was also validated by the support of our customers who attended our User Fforum, held two weeks ago in Miami. We had record attendance, up 20% this year, with customers representing a cross section of our markets coming from around the world. The theme of the forum this year was "Race to Resolution," highlighting our product's innovative capabilities to accelerate the time to resolve our customers' most complex and critical application service problems.

We heard customers present how their use of our products is evolving from tactical incident resolution to strategic management of network and application services as networks become more complex and critical to business performance.

In addition, we are really excited about the overwhelming positive feedback we received at the User Forum about our recently announced acquisition of Network General. We got widespread enthusiasm from our customers for the combination of the two companies. We also hosted a number of Wall Street analysts for an analyst day, and we received affirmation from them following the event, as evidenced by the positive comments in their notes, typified by one characterization of the acquisition as being a significant and transformational event for NetScout.

Part of the significant transformation of NetScout is an increase in the number of analysts covering our company, up to six -- that is double the number of the last few years.

We are on track to close the acquisition in early November, and we have already received HSR regulatory approval from the FTC.

Today, the integration efforts are going well, and we are on schedule to complete the organizational integration by April 1, 2008. We are still working through the details of the combination of the two companies, including transitional costs and expenses, and as a result, we will not be giving financial guidance for the current quarter. We expect to resume -- providing quarterly guidance on our regularly scheduled third-quarter earnings call in late January. In the interim, we'll be filing an 8-K by January that will include the combined historical financial results through the period ended October 31.

We are confident of achieving our previous outlook, which was discussed at the announcement of the acquisition, that we expect the combined company will approximately double NetScout's current revenue run rate in the full year of fiscal 2009. In addition, we still believe the transaction will be a accretive in the full fiscal year of 2009 on a non-GAAP basis.

We believe that the combination will prove to be a watershed event for NetScout as well as its customers. It will improve our competitive position in the market and enhance our revenue growth due to our new ability to provide a more comprehensive, best-in-class solution to our customers. We'll be able to provide NetScout's leading edge and real-time monitoring and analysis combined with Network General's Sniffer best-of-breed deep-packet inspection that will, overall, provide a more valuable lead time resolution solution to our customers.

In addition, we will be doubling our R&D effort, and over time, we'll be able to combine our separate functionality into an integrated solution that will lower the total cost of ownership to our customers and provide a seamless, more powerful application performance management solution. And we'll be able to sell that more valuable solution to an expanded customer base through a combined, direct sales force that will be more than double the size of NetScout's current sales force.

In summary, the combination of NetScout and Network General will be able to drive growth, and by leveraging our combined infrastructure, we'll be able to improve profitability. We are very excited about this combination and we are pleased by the strong endorsement we have received by our customers and investors so far. We look forward to sharing with you more news about our new company in the coming quarter. I would like to thank our employees, customers and other stakeholders for their support as we enter this exciting new era for NetScout.

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

Thank, you Anil. Our quarterly financial results are in the financial statements, which are part of our earnings press release. Our second quarter revenue of $29.6 million was within the range of the revised higher guidance we released on September 20.

Revenue was up 18% year over year, and up 6% over the previous quarter. Net income for the quarter was $3.3 million, up 41% on a year-over-year basis and up 21% sequentially. Earnings per diluted share were $0.10 on the high-end of the revised guidance range of $0.09 to $0.10. Revenue contribution from direct customers was 32% compared to 36% last quarter, reseller revenue made up the balance.

We added 22 new customers worldwide for 15% of total orders. The rest of our order volume came from 232 repeat customers. Fifty-nine customers gave us orders over $100,000 this quarter, including 13 customers with orders over $500,000 and five orders over $1 million. One of the $1 million deals came from a new customer in the banking industry, a large, retail, discount brokerage house where we're monitoring their trading network. We also had a large government order as part of the SPAWARS Program.

Revenue from international sales was 18% of total revenue, up from 15% last quarter, with Europe at 14 points and Asia at 4 points.

In our vertical markets this quarter we had strong bookings coming from financial services sector, representing 39% of order dollar volume (company corrected following call), followed by a strong quarter for the government sector at 26% and telecom at 12%.

Turning back to our financial picture, our gross profit for the quarter was $22.9 million, up 18% year over year and 6% sequentially. Gross margin was 77% in the quarter, flat, compared to a year ago and down 1 point sequentially. Operating expenses in total were $19.3 million, up 15% year over year, and up 2% from last quarter.

Income from operations was $3.6 million, which included $326,000 of stock-based compensation expense, and $105,000 of amortization of intangible assets from the acquisition of Quantiva.

Operating margin was 12% for the quarter, up 2 points from last year and 2 points over last quarter. We're continuing to progress toward our long-term operating margin goal in the high teens.

And now turning to key balance sheet measures, cash and marketable securities are $108.9 million, up $3.7 million sequentially and a year-over-year increase of $18.2 million. Accounts receivable, net of allowances were $18.7 million, compared to $15.9 million last quarter, and $17.9 million a year ago. Days sales outstanding were 58 days for the quarter, up from 51 days in the prior quarter and slightly above our target range of 45 to 55 days. Inventories were $4.9 million, even compared to the prior quarter.

As Anil mentioned earlier, we will not be issuing guidance today for the third quarter. We expect to resume guidance in our next earnings conference call scheduled for January. Again, thank you for joining us today. We look forward to taking your questions. Please go ahead, Francis.

(OPERATOR INSTRUCTIONS). Your first question comes from the line of Eric Martinuzzi from Craig-Hallum.

Thank you. Congratulations on a very successful quarter.

Thank you.

The -- my questions has to do -- in the absence of guidance, I'm trying to figure out where the product growth goes. Now, obviously we had the comps from a year ago were not as challenging as maybe you had hoped they would have been back in 2006 -- calendar '06. But we're looking at 21.5% growth in product for the first half of '08 versus the first half of '07. Now, historically, you guys have commented that you expect to be a 15% plus grower. Where do we come out between those two numbers, just as far as the things that are driving your business thus far in the year?

You're asking for a comparison of growth a year ago versus growth now or growth numbers?

Well, it seems the growth thus far this year would be well above that 15% number that you've thrown out in the past. I'm wondering is there -- does that decelerate in the back half of the year or are the trends that have driven it thus far still in place?

I think for the usual business, like I said, is we have provided guidance, there was -- it didn't make sense to provide standalone guidance. Yeah, I think that will be true. But the reason we are not providing guidance for the combined stuff -- in the standalone one is because it doesn't make sense. So I don't know, David, do you want to comment whether you have any numbers for --

The trends going forward, Eric, are all still in place. I mean, this quarter was strong year-over-year growth. As you know, our third -- we talked about the fourth -- third and fourth quarters are typically our strongest quarters, and that's the period we're entering. So we think that's all the current quarter order strength is a very healthy sign.

In terms of long-term growth, we have a lot of integration in front of us and a lot of market opportunities to capitalize on. We don't think there's anything in the new acquisition or the market trends that would lead us to conclude that growth is going to slow down substantially. I think the 18, 20% growth that we showed this quarter is certainly at the high-end of the range that we talked about, so that's an encouraging sign. But I also think we're ready to raise long-term growth guidance. Too many things in front of us to accomplish.

I understand. Okay, and that's helpful. And then just a couple of industry trends. You've benefited from the wireless carrier spending as they shift to IP networks. You've also talked in the past about virtualization as a positive impact for you. Where are we on both of those trends as far as near-term contribution to your growth?

I think all this -- some of the traction we're getting is a result of that. So when we talk to virtualization we, as you remember last time and at the user forum, we had talked about virtualization in terms of convergence, how a network is being shared by various services and creating a new kind of challenge in terms of performance monitoring. And that's especially relevant in the financial sector.

And so some of the traction you are seeing and the better growth we are seeing in the first half means that these things are important to the customer, and some of those we are already addressing.

On the wireless service provider, also have seen some traction, but one of the reasons we have done the acquisition is to really combine some of the best of breed we think people looking at with some of the vendors they're considering right now. And so we think that we can have a much better impact in that area because of the acquisition some time this year.

To summarize, both of those things are some of the reasons why we are getting traction and as a result of our strategy last year, the focus on this area besides the government. But I think there are wireless opportunities still ahead of us.

Thank you.

Your next question comes from the line of Matt Robison with Ferris Baker Watts.

I'll add my congratulations. A couple of housekeeping things to start with. Can you give a headcount, operating cash flow and CAPEX?

Yeah, let me start working on getting that data.

Maybe, Anil -- maybe you could help us out a little bit with the product mix, if there's any -- have you seen any significant trends in terms of maybe AFMon versus some of the other products and software or if there's anything in particular that's driving the business more than it was?

I think that, basically, the AFMon is more high-priced per segment because of the additional software and hardware complements. So yeah, average deal size has increased, the amount of AFMon business versus probes is increasing, but that was expected. So, I mean, that's one of the reasons we are successful and there is a lot more people looking for AFMon now than they were looking at before.

Basically, it's the same customer base, but it's graduating to new kind of applications. We are -- AFMon is more relevant. So AFMon is consistently improving. Probe is still the lion's share of the total instrumentation business, but AFMon is increasing consistently, and it was higher than ever before.

We talked on -- back at the conference. You talked a little bit about how things looked with Infinistream and AFMon, and maybe you can kind of elaborate a little bit on that and what you think is going to happen. How do you envision those products selling together if there's going to be a -- if they're additive or if there might be a tendency for one to sort of displace the other as a team?

What I think basically the hardware components of both platforms is identical, even though they are different from different vendors, but they both essentially serve the same purpose. But both companies are really software companies and NetScout has focused on one area of the software, which is reporting and alarming and things like that. We have Network General has focused more on a different application, which we call a deep-packet analysis and mining area.

And some time when somebody wanted to buy a box and they had to choose between Infinistream or AFMon, but when in reality they wanted both the functions in a single box, and the reason for widespread deployment of the instrumentation of boxes. And that was prevented because of this issue. Now, when we can combine the combination of both the features for the application in a single product, the cost of ownership for the customer actually comes down dramatically per segment. But we hope -- we're hoping that this will allow them to duplicate that experience on a wider scale in the network; whereas, the revenue for customers will -- will go up, while the cost for management is really going down for the customer.

Okay, thank you.

Matt, on your earlier questions, headcount was 378, operating cash flow $3.6 million and CAPEX $1.3 million.

Your next question comes from the line of Manny Recarey from Kaufman Brothers.

Hi. Good afternoon, and thanks, guys. Just a couple of questions. One on guidance. If I understood correctly, the trends are such that you should experience your typical seasonality and see revenue increase sequentially as we move from the September to the December quarter. I mean, there's really nothing that should change that historical seasonality, correct?

Certainly, the trends are all -- the season is upon us and the trends are all going to happen this year as they happen next year. In the combination of the two companies, however, we can't give specific revenue guidance as to how that's going to compare to a year ago or to the current quarter. Too many moving parts there and the deal's not closed yet.

Yeah, that I fully understand. Looking more from a NetScout perspective as opposed from a combination. But that's good.

The second question would be the gross margin trend in just the last couple of quarters; I mean, it's still a very strong growth margin, but it has trended down a little bit. Any comments on why it's trended down the last couple of quarters.

Sure. And we have always been -- tried to make clear that our gross margin has a couple of factors in it that can swing back and forth, and they swung over the last year or more in our favor until recently, and a couple of them started swinging against us.

Our gross margin target model is still 76 to 78, and we're right in the sweet spot of that, but those factors are a mix between product and service revenue. Our service revenue is high-margin revenue because it includes -- our maintenance contracts include, essentially, a subscription to our new -- our future software development, and that's high value to our customers. So those margins, which you can see in the income statement, are in the mid-80s. Our product margins, because of the hardware content, are typically in the 70s. Product revenue, when we're growing, leads the growth of service revenue. So as we grow product revenue faster than we grow total revenue, that will have a depressing effect on aggregate gross margins.

The other factor that happens within gross margins is product mix, and although most of our hardware products are pretty comfortable in margins, occasionally, there will be a swing in what customers buy that will cause a little bit of variability.

Okay, thanks. And one last question. You had mentioned the financial services vertical was particularly strong for you. Was that due to the large contracts that you received? Because in another number of other companies within this sector, it has experienced some weakness in the financial services vertical.

Well, we have received some significant contracts, one of which I mentioned earlier from financial services; one large new customer. And we have a solid stream of follow-on business from existing customers across the financial vertical, including exchanges, investment banks, commercial banks, insurance companies. So it's a pretty typical pattern for us, so I guess the answer is we haven't seen the weakness that you might have been -- you might have seen elsewhere.

Okay, great. And congratulations on the good quarter.

Thank you.

Your next question comes from the line of Scott Zeller with Needham & Company.

I wanted to ask about growth in the future; a couple of questions. We've gotten around what is the cross-selling opportunity. My understanding is that customers may have both solutions from Net Gen and NetScout, but can you talk about the size of the customer base again at Net Gen and what you think the opportunities are for growth and for cross-selling?

I think we -- I mean, we don't have -- maybe you want to go over the quantitative measures right now, but qualitatively, there is -- while customers have used both the products, but if you look at it in terms of their top-end customers, there is very little overlap.

And so there is a lot of cross-selling opportunities, as I answered the previous question, that customers -- some customers are using the product for -- one of them for Feature A and another customer is using for Feature B. And I think there's a new opportunity when they can get A plus B at the same price in terms of the number of -- in terms of the box they have to buy. So that will be some, I think, cross-selling opportunities. And I think we're excited about it because the model overlap is actually quite small in the high-end customer base.

Now, in terms of the number of customers, yeah, it is fairly large compared to NetScout, but really, the big, high-end of the market is the top-end customer we are focusing on, and that's where I think the opportunity is the big difference.

Okay. Thank you very much.

Your next question comes from the line Steve Koenig from KeyBanc Capital Market.

Hi. Thank you very much. Good afternoon. Your -- in looking at your stock, clearly investors are very excited about the Network General acquisition, and we got a good sense that there are a lot of potential product synergies and customer interest in the combined company, certainly at your analyst day.

There's not a lot of financial information, and understandable with regard to guidance. I am wondering though in terms of financials, can you give us any sense of Network General's operating profile? For example, in terms of TPM revenues or margins.

Steve, unfortunately we can't. The deal hasn't closed, and they are still private. And although the deal is going to close, we are confident; we are not at liberty to disclose that.

We have said, as I'm sure you know, that we expect -- we reiterate it again today -- that we expect in '09 that we'll be about double the size that we are at the moment as a standalone as NetScout in a combined company in terms of top line. And I know that's not exactly the question you asked, but that's kind of the best we can do right now.

Okay, I understand. You know, with regard to doubling the revenues, is that after -- do you expect to be pruning any revenue streams from Network General?

We are always going to look at how we integrate and take best advantage of their products and maximize the revenue stream. We're not going to -- we're not in the business of throwing away revenue. And we don't have all those plans worked out yet. We will be detailing them over the next several months. But when these combinations happen, there is always some revenue leakage and confusion in the marketplace, realignment of sales territories, etc., that causes some loss of revenue momentum. And we're anticipating that that may well happen here. We're doing everything we can to minimize it, but yea.

I think one thing to add there is, yeah, we have taken all this into account when we provided the general guidance that David is talking about. So we are hoping in spite of all these issues, revenue leakage or some changes in clients and things like that, in the very first year -- for the first full year, which is the coming year, we'll be about that size.

Okay, that's helpful. And so I guess qualitatively then on the flipside, can you give us any commentary on cost and revenue synergies with Network General and how those might unfold over time?

Well, we're not counting on substantial revenue synergies. We -- in Year 1, as we combine the companies, we certainly think there's great opportunities -- Anil articulated it -- to grow revenue over time because of our -- the improved market position and value proposition that we have, but we're not counting on that and that's not a synergy, per se, in the business case. That's the value of the combined solutions.

The synergy we are working on is the elimination of redundant function in the two companies, and the two companies are approximately the same size. There is -- there are redundancies that we can remove, and that's where the synergies are coming from, and that's why we're confident that we can achieve the non-GAAP accretion that we talked about earlier.

Is that helpful?

Yes, it is. And certainly being sensitive to the fact that the integration is still unfolding, are you able to say are the cost synergies, are they strictly back office or does it go -- can it go beyond that?

It is back office but it's across -- broadly across the organization; not in all places. We're trying to do this in a sensitive, discrete way. And where there are clearly overlaps, we're minimizing those overlaps, and where there are no obvious overlaps, we're leaving the organizations alone. So it is not just in the back office. It is across the organization broadly.

Okay, great. Then one last question. One thing that might be helpful would be to get your take in terms of the impact on the competitive environment, especially maybe for me and any other listeners who are maybe a little less familiar with the market competition in your sector. I'm curious to know which of your competitors do you think have the most to lose from a hookup with Network General? And in what areas and with which competitors do you expect to be able to increase your win rate, become more competitive with, etc.?

Okay. I think we can -- yeah, I can talk about maybe -- I'll give you a couple of pieces of information of the competitive environment. But the Number 1 reason for future growth is to deliver -- is to be the solution through the existing joint customer base and create more widespread deployment of our product organization to solve the conflict all our customers are facing with the virtualized and converged network environment.

So that's a -- that's a Number 1 value. Clearly, that's not a competitive play. That's really, I guess, untapped dollars. But nevertheless, when we do that, there'll be some kind of competition, and there are three types of players. One are small startups; I mean, clearly, we didn't do it for this reason, but yeah, there will be some competition from there.

And the wireless service providers, there are some big players, like Tektronix and Agilent. And you heard about the Tektronix news with (inaudible). We like to see how that impacts, positively or negatively for that. And the third one will be the competition for MindShare where all the big players, whether it's Cisco or some of the people we partner with who are management solution are going to be competing for dollars. And that's the competitive environment.

But we feel there is a lot of untapped opportunity, despite this competitive environment, which is really delivering the complete, potential value of this solution set.

Okay. And lastly, do you see that the acquisition would change at all your profile in terms of indirect channels or other partnering opportunities to increase your visibility into the marketplace and your ability to better proliferate within your accounts and get more of the opportunity?

Well, as we mentioned in the -- just in my description of how the business will be done, we are doubling the sales force headcount with the combinations of -- in U.S., at least, there won't be any big change in effect of the channel. But international, we have to look into opportunities because Sniffer was a good brand name, and we are still investigating what the brand name -- if we can take advantage of that with the new set of products we have with the combination.

Okay, great. I appreciate your help.

(OPERATOR INSTRUCTIONS). Your next question comes from the line of Peter Jacobson with Brean Murray, Carret.

Okay, thanks. Hi, everyone. With respect to the integrated product coming out in about six or seven months, are there any customers that are saying, "Well, rather than buying now, I'll wait until that availability of that integrated product"?

Well, I think one of the stories that we have mentioned is the user forum. First of all, we have not been able to talk to all the customers, but we have really not heard of any big concerns. But the message to everyone is that the integrated product is really a software integration, and it's going to be available to anyone who is buying right now from either company as well as to people who have bought with either company in the past. And because of that, there is very little, if any, concern in the customer base that we know of who is in this holding pattern.

So does that mean it's a free upgrade to an integrated platform?

Well, the basic integration is obviously free, but there are options in each product line, and that, we'll have to look into that. But the basic integration, which is combining the two things together; so if you bought A and you bought B then obviously A plus B is included. So it's not -- it's sort of simple answer to that, but there are options in each product, and if you want to have to -- want to buy the option in the integrated product and you didn't pay for the option before, obviously, you'll have to pay for it.

Okay. And any more visibility to the timing of the Hewlett-Packard integrated product that's due out in a couple of months? And do you expect that to start generating revenues relatively quickly or will that take some time to start to ramp up?

No, I think it's going to take some time to ramp up, and all the guidance we are going to provide or what we have provided so far loosely for the next year is going to think of HP as more of the upside to that rather than being requiring that to do that. So that is strictly based on the combination and what we are doing today. So hopefully they'll be upside, but we are not necessarily counting on it.

Okay. Thank you very much.

There are no other questions at this time. I will now turn the call back over to the presenters.

Thank you very much. We certainly appreciate your interest and participation in our conference call today. We look forward to talk to you again in our next conference call in January. Good night.

This concludes today's NetScout second quarter of fiscal year 2008 conference call. You may now disconnect.