Netscout Systems Inc (NTCT) 2012 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to NetScout's second quarter fiscal year 2012 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 and NetScout's Chief Operating Officer Mr. Michael Szabados. 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 morning, everyone. Welcome to NetScout's fiscal 2012 second quarter conference call for the period ended September 30.

Before we begin, 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 may influence our results going forward. These statements include forward-looking statements made pursuant to the Safe Harbor provisions of Section 21 E of the Securities and Exchange Act of 1934 and other federal securities laws. These forward-looking statements they involve judgment and individual judgments may vary. Forward-looking statements include express or implied statements regarding future economic and market conditions, guidance for fiscal year 2012, acquisition integration success and new product releases.

It should be clearly understood that the projections on which we base our guidance and other forward-looking statements 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 during the year such as during the quarterly earnings call. We do not plan to update that guidance otherwise. 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. For further discussion of the risks and uncertainties that could cause our actual results to differ, see the specific risks and uncertainties discussed in NetScout's annual report on form 10-K for the year ended March 31, 2011 on file with the Securities and Exchange Commission.

Our quarterly financial results are included with our earnings press release. We report our results on a GAAP basis, as well as on a non-GAAP basis. Our non-GAAP results eliminate the GAAP purchase accounting effects of the acquisitions by adding back revenue to deferred revenue revaluation and removing the amortization of acquiring tangible assets. In addition we remove the GAAP effects of stock based compensation. Our non-GAAP results only also exclude certain extraordinary business development expenses for outside services that we incur from time to time in pursuit of potential acquisitions. We exclude the related impact of all these adjustments on the provision for income taxes.

The difference between GAAP and non-GAAP are disclosed in reconciliation tables in the press release. We believe these adjusted financial measures will enhance your overall understanding of our current financial performance and our prospects for the future. We use these adjusted financial measures internally for the purpose of analyzing, managing and forecasting our business.

Thank you, and I will now turn the call over to Mr. Anil Singhal, our Chief Executive Officer.

Thank you, Cathy.

We are pleased with our strong second quarter. Revenue in Q2 was $72.6 million, an increase of 15% sequentially and 5% year over year. We effectively controlled expense growth in the quarter, expanding non-GAAP operating margins to 23% which was flat year over year. New business and total bookings increased 30% year over year. Looking at the first half of this fiscal year, new business bookings were up 9% and total bookings were up 16% over last year.

For the first time in several years, we have exited a quarter with a material backlog of product orders, which we define as $10 million or more. At the end of the quarter, we have $14.5 million of orders in the backlog and deferred product revenue, all of which has been shipped creating a fast track to the second half of the year. We believe we are on a good track to achieve our second half financial target and are reaffirming our guidance for fiscal 2012.

We performed well in all vertical segments and we're particularly strong in government and financial services, posting significant year over year and sequential quarterly increases. There was a strong recovery in the US federal government purchases despite general concerns about future spending constraints. Our solution has significant value to the federal government, and the Department of Defense in particular, helping them to compensate for reductions in spending on people by increasing the use of advanced communications technology. We believe that this value will buffer our federal business from some of the impact of reduced overall spending. However, our federal business remains subject to significant uncertainties because of the ongoing budget debate.

Our enterprise new business bookings excluding government grew strongly, driven in large part by financial services with good contributions from healthcare and high tech. Despite continued profit pressure in financial services, some of our top banks, the customer made significant purchases to manage critical systems in support of business initiative driving competitive advantage. Our enterprise goal is in part to the success of service delivery manager and enterprise intelligence products, which are important elements of our unified service delivery management or USDM initiative in the enterprise space. USDM is gaining understanding and acceptance among enterprise customers as a valuable framework for a [inaudible]-based early warning analysis of services delivered by the most complex virtualized infrastructure. We will be explaining more about the power of USDM in the coming quarters.

Growth in service provider bookings was good and came in as expected. We established a good technology foundation to serve both enterprise and service provider customer market. For example, our InfiniStream products are common across both markets, and our Service Delivery Manager product is being rapidly adopted by our customers in both sectors. The benefits of being a leader in both service provider and enterprise are just beginning to emerge in our business results and we are pleased with our progress and more and enthusiastic than ever about our unique potential as the markets begin to convert.

During the quarter, we announced the acquisition of Fox Replay, an addition that borders our entry into the cybersecurity market where there is currently strong and vertical demand particularly in government. Replay has particular technology and expertise that will be an important contribution to expanding our Unified Service Delivery Management platform into security operations. Replay is based in the Netherlands and a leading provider of special reconstruction replay technology that enables organizations to perform forensic analysis of end user actions in support of cyberintelligence and lawful intercept. We are planning to release a new product in the form of a cyber security appliance in the first half of next calendar year.

In summary, the second quarter was very strong in business law, confirming the strength of our technology and market position, and setting the stage for achieving our second half expectation and long term revenue growth target of high teens.

In early November, we will be hosting an Investor Day in New York to more fully explain our direction with USDM and the new market strategies and why we believe they will enable us to realize these short and long term goals. The Investor Day management presentation also take place on November 11, from 8AM to noon and will be webcast live.

Now I'll pass the discussion to Michael for discussion of additional highlights of our performance.

Thank you, Anil.

I would like to focus on our operational performance from this past quarter and provide you with insight into the plans -- into our plans going forward. In addition to Anil's comments, our strong performance this quarter I also want to note that we are pleased with further executioning doing our new business in US federal and acrossand all the enterprise subsectors but particularly in financial services. In addition, our Asia Pacific area continues to grow well and is developing many of our new customer relationships. Lastly, in our service provider business we are growing our organization into our tier 2 wireless service providers and cable operators on top of our existing tier 1 successes.

In our services business in Q2, we set a new record for service renewal bookings for September quarter, with a high maintenance service renewal rate, which affirms the loyalty of our strong customer base. As we expand our solution offerings, we are maintaining a solid and balanced development stream of new functionality for both wireless service providers and across all enterprise segments, including expansion through the product line for revolutionary new adaptive session intelligence, or ASI, technology.

In recent quarters, we have begun to ran out our suite of unified service delivery management offerings for our enterprise customers encompassing functionality for unified communication management, communication management, cybersecurity, and application performance management to address our customers' IT operations management needs. All of this is built on the portable foundation of our engineers nGenius InfiniStream packet flow technology.

For unified communications management, our flagship offering is our new voice and video management, or NVVM product line, that derives from the acquisition of Psytechnics in April. Our new NVVM product sales are off to a good start, enlarging our opportunity both in the installed base and renew customers. The second quarter was our first quarter of selling NVVM. We have had strong pipeline growth in this quarter and the initial sales are in line with our expectations. During the quarter, the NVVM offering with the capability of using our InfiniStream appliances at data source which opens the door for existing customers to leverage their installed instrumentation for unified communications applications. With NVVM's focus on managing voice and video applications, we expect to appeal to new users in addition to our traditional network and application manager user base in both current and new customer organizations.

Our second acquisition of the year, Fox Replay, builds on the existing cybersecurity-oriented monitoring and forensic capabilities of our engineers' offerings. As noted by Anil, our acquisition of Replay will serve to expand our offerings to customers with initial sales to government, both defense and civilian agencies and with particular focus on the US federal government. Our planned product line integration and expansion in calendar year 2012 will broaden the addressable market with a Replay solution to large set of enterprise users.

In application performance management, our nGenius service delivery manager and nGenius intelligence product last quarter are gaining wide acceptance. With this functionality incorporating our new ASI technology users have a management system with analytic system-wide performance for proactive end to end management of the IT services and applications as experienced by the users. Service delivery manager and enterprise intelligence are major elements of our broader unified service delivery management or architecture which encompasses application performance management, unified communications and cybersecurity.

Also in Q2, we continued our investment in building market awareness and broad-based demand with out USDM road show, conducted jointly with Cisco in ten cities across the US. These multiple-city events, which were well attended, explained the linkage between USDM and Cisco's borderless networks initiative as well as our new NVVM product for unified communications.

In conclusion, the flow of significant awards for us continued during the quarter, including the recognition of NetScout's by Fortune Magazine as 19th fastest growing technology company for 2011.

I want to thank you for attending our call today and I would like to turn it over to David Sommers.

Thank you, Michael.

In the second quarter revenue was $72.6 million, up 5% year over year. Product revenue was $38.1 million, up 2% year over year. Service revenue was $34.5 million, up 8% year over year.

Our GAAP gross profit margin for the quarter was $57 million. GAAP gross margin was 79%, flat year over year. On a non-GAAP basis, gross profit was $58.3 million, and gross margin was 80%, down one point year over year.

GAAP income from operations was $11.5 million. GAAP operating margin was 16%, down three points from a year ago. GAAP net income for the quarter was $7.1 million, yielding earnings per diluted share of $0.17. GAAP net after tax margin was 10%, down two points from a year ago.

Non-GAAP income from operations was $16.4 million, and operating margin was 23%, flat compared to a year ago. Non-GAAP net income was $10.3 million, or $0.24 per diluted share. Non-GAAP net after tax margin was 14%, down one point from a year ago. The non-GAAP adjustments to our GAAP results are summarized in the reconciliation table included with our press release.

The provision for income taxes is recorded based on a full year effective tax rate of 34.2% on a GAAP basis. Our GAAP tax rate in the quarter is 33.9%. We've used the statutory tax rate of 38% to tax effect of non-GAAP adjustments.

In the first half, Q1 and Q2, the product revenue was $67.6 million, down 5% year over year. Service revenue was $68.3 million, up 5% year over year, and total revenue was $136 million, flat versus a year ago.

Our long term model, which is subject to regular review, remains as follows - Non-GAAP gross margin is 78% to 81%, R&D expense to revenue, 13% to 15%, sales and marketing expense to revenue, 33% to 35%, and G&A expense to revenue is 6% to 8%, yielding an operating margin range of 24 to 27%. This model applies to our full year results. Individual quarters may be outside the range. Similarly, our long term revenue growth target remains high teens annual growth.

We exited the second quarter with cash in short and long term marketable securities of $199 million, down $10 million in the quarter, and an increase of $3 million year over year. During the quarter, we were active with our stock repurchase program, buying 1.27 million shares for $16.2 million, an average of $12.75 per share. We activated the program because of the unusual value that our shares presented in the quarter. We plan to be active from time to time in the future, supported by our strong operating cash flow.

Free cash flow was $9.5 million in the quarter. Capital expenditures were $3 million, depreciation was $2.5 million. Amortization of acquired intangibles was $1.6 million.

Marketable securities included investments and auction rate securities valued at $17.4 million. As of September 30, the value of these securities includes a temporary decline in the value -- in value of $2.1 million below par to reflect liquidity concerns. All of these investments have a AAA investment grade rating with underlying support through the federal government through the Federal Family Education Loan Program.

Accounts receivable net of allowances was $49.7 million, up from $41.4 million last quarter and a year ago. Day sales outstanding were 62 days for the quarter above our typical DSO range of 45 to 55 days. This is up from the prior quarter of 57 days and above DSO of 53 days last year.

Inventories were $9 million, down from $9.6 million last quarter and down from $11.4 million a year ago. Inventory turns were 2.4

times. Turning to other metrics for quarter, revenue contribution, direct customers was 46% and reseller revenue was 54%. Revenue from international sales was 24% of total, down 5 points from last year. Europe delivered 10%, down 5 points from last year. Asia came in at 6% up one point, other international sales were 8%, down one point compared to last year.

Summarizing our large deals, 152 customers gave us orders over $100,000, an increase of 30 customers over the same period last year. 34 customers gave us orders over $500,000, up from 32 last year. We got 14 orders over $1 million dollars of which five came from telecom, five from financial services, two from government, and two from healthcare. This compares to 13 $1 million or more orders we received last year in Q2, including five from telecom, four from financials and four from government.

We saw a total bookings from the following sectors in the quarter -- Enterprise was 54%, telecom 23%, government 23%. In the enterprise, financial services was 31% of the 54. A year ago, enterprise was 52%, telecom 22%, and government 26%,and the financial subsector of enterprise was 29.

Total bookings in Q2 were $88.2 million, up $20.8 million or 31% year over year. New business bookings were $68.1 million, up $15.6 million or 30%. New business bookings increased significantly with a resurgence from orders from government following last quarter's stalled order flow due to the budget crisis. We also saw a return of strong order flow from financial services.

In the enterprise, our new business bookings were up 44% over Q2 last year. The financial services subset of enterprise was up 38%. The rest of the enterprise sector up 54%.

New business from the government sector globally was up 24% year over year, led by the U.S. federal government, which was up 26%. Service providers new business bookings were up 10% over Q2 last year.

For the first half, total bookings were $141 million, up $19 million or 16% year over year. New business bookings were $105.6 million, up $9 million or 9%. In the enterprise, our new business bookings were up 8% over last year, the financial services subset was down 8% and the rest of enterprise was up 36%.

New business from the government sector globally was flat, with the US federal government up 4%. Service provider new business bookings were up 20% year over year.

Service contract renewal bookings in the quarter were $20.1 million, up $5.2 million or 35% yearover year.

Product backlog at the end of Q2 was material. We are entering Q3 with product backlog and deferred product revenue of $14.5 million. Total deferred revenue was $90.2 million, up $3.2 million over last year. Growth and deferred revenue in the second quarter is unusual for us due to the seasonality of our maintenance service renewals, which are strongest in Q3 and Q4. As Michael mentioned, this out of season strength is confirmation to the value that our continuing development delivers to our customers under maintenance.

As we discussed in the last earnings call, our shortfall in the first quarter should not be viewed as indicative of the level of our performance for the remainder of the fiscal year or the future. Similarly, the strength of our Q2 bookings by itself is not indicative of our performance for the second half and beyond. We expect that the obvious volatility of our results, driven by unusual uncertainty in many sectors of the market, will continue. However, we are confident in our ability to deliver our guidance for the full year based on our careful analysis of our sales pipeline.

We entered Q3 with a material backlog that reinforces our positive outlook for the balance of fiscal year 2012. It is our intention to continue to carry a material backlog.

Similar to last year's revenue seasonality, we expect this year to be back end loaded with more than 20% higher revenue in the second half than in the first half. This will be driven by several factors, including the continuation of moderate federal spending, the growth and normal seasonality in both telecom service provider and in enterprise demand, including financial services. In addition, the second half will benefit from the good market acceptance that we're seeing for our new voice and video product resulting from the Psytechnics acquisition, and a modest contribution from our new Replay product line, and we are on track with the expense management that we announced in July.

We are, as Anil said, reaffirming our fiscal year 2012 guidance issued on July 4th. We expect revenue to be in the range of $300 million to $315 million, GAAP net income per diluted share is expected to be in the range of $0.84 to $0.97 and non-GAAP net income per diluted share between $1.07 and $1.19.

Fiscal year 2012 non-GAAP income per diluted share expectations excludes the share-based compensation expenses of approximately $8.5 million,estimated amortization of acquired intangible assets of approximately $6.9 million, business development costs of approximately $2.5 million, which includes costs associated with the integration of Psytechnics and the acquisition of Fox Replay,and the related impact of these adjustments on the provision for income taxes of $6.1 million.

That concludes the financial discussion this morning. Thanks for joining us again, and we look forward to taking your questions. Jonathan, would you go ahead, please.

Ladies and gentlemen, at this time, if you would like to ask a question, please press star, then the number 1 on the telephone key pad, we'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Alex Kurtz with Sterne Agee. Your line is now open.

Thanks for taking the question. Nice quarter.

David, can you talk about material backlog? I mean is this a new level for you guys and sort of gives you increased confidence in sort of hitting the second half numbers?

Alex, it's a new level since the bulge of orders we got immediately after the Network General acquisition back in fiscal 2008. So in normal times, yes, this is a record level of backlog. It has always been our intent to carry a backlog for many reasons, one of which is it obviously gives us better visibility into the near term future, and that is important to our confidence about the second half.

So this is a record level backlog, then? Is this your largest ever?

No. Sorry. Since fiscal 2008 when we acquired Network General, it's the largest since then. In the Network General acquisition, there was a rash of order business that we couldn't all ship, and it built a backlog that was larger than this at that time. But that was an acquisition artifact. If you're ignoring that artifact, yes, this is the largest.

And last question. Again, you mentioned the long-term growth of what mid to high teen?

Yes.

For revenue. You know, let's put some time parameters around it.

Well, as you know, we put it in the context of our operating margin model, which is our objective. And although we have our own internal targets for achieving -- time frame for achieving that kind of growth, we don't disclose them any further than that that is our objective. Sorry.

Okay. Thanks, guys.

Your next question comes from the line of Eric Martinuzzi with Craig-Hallum. Your line is now open.

Thanks. Congratulations on the strong quarter, and it's good to see a quarter that's lumpy to the good as opposed to the other direction.

Thank you.

The government bounce back -- I'm curious, obviously you guys ... there was weakness there in June and you -- as you gave the guidance for FY 2012, you said you weren't expecting real positive impact there, and yet you saw a substantial bounce back. What is it that caught you by surprise as far as your own pipeline analysis there?

I think I'll just say a couple of things and then maybe David can add to it.

So first of all, we were much more cautious about that, the predictions for this quarter because of the issues we had in the last quarter for predicting the federal business. So some of it was benefit from there, and also it's close to the end of the fiscal year for federal, so our pipeline looked very good. But we were not sure because of all the other confusion happening in that space, what really we could be able to deliver, and it just turns out that we were able to fully capitalize on the pipeline.

Let me just add to Anil's insights.

You may recall when we talked about the June quarter, we said that we had federal -- good federal business in the pipeline that just didn't materialize at the very end of the quarter because of uncertainty in the procurement process and disruption of the priorities in the buying pattern. That was unusual. We had never seen that before, certainly to that degree. So we were cautious even though coming into Q2 and the balance of the fiscal year with good federal pipeline and opportunities --we had those pipeline opportunities, the ones that we said didn't materialize in June didn't go away. So we knew that there was good business potential. The open question was how would the federal buying patterns roll out, unfold?

And that's why we were cautious, and that's why we said we weren't sure. We weren't counting on seeing a big uptick. In fact, if we hadn't seen the big government uptick, we still we wouldn't have built a backlog like we did but we still would have had a good quarter. But as it turned out, there was a significant rush to the door in federal spending at the end, and we were able to participate in that very strongly.

And some of the federal business that we got is from existing customers who are significantly reaffirming their investment and commitment to our product line, so that's very encouraging. And they are in the areas of the advanced use of technology that we refer to in the prepared remarks, which bodes well for continuing federal business in the future. However, having been surprised in Q2 -- in the June quarter in Q1, we remain cautious about the dynamics of the federal buying process, not about the enthusiasm of our federal government customers over our product solution.

Just a housekeeping question. The share count that's implied in your guidance for FY 2012 or maybe the share count that you finished up September with?

It's 41.7 million shares.

Okay. Thank you.

Your next question comes from the line of Mark Kelleher with Dougherty & Company. Your line is now open.

Thanks. I wanted to ask about the Fox Replay expectations. You said that that was probably a modest contribution this year, this fiscal year, and then what are your expectations for longer term?

Well, first of all, yeah, because by the time we get ready to really utilize our sales force for this, it will be January time frame. And so we have to rely on the current pipeline, which is modest, being a small company. And so that's what -- that's why we started modest. I think next year, we will not be able to separately qualify Psytechnics or Fox Replay contribution but it will be part of our yearly guidance, we going to give full year guidance again next time at the end of this fiscal year.

So we do expect a significant, as Anil said, a significant but unquantifiable contribution to these acquisitions in our growth going forward. So in answer to -- in support of the earlier discussion of long-term growth, the acquisition activity is clearly part of that.

Okay. Great. Thanks.

Your next question comes from the line of Aaron Schwartz with Jefferies. Your line is now open.

Good morning, and congratulations on the strong results in the period. I had a follow-up question on the backlog. It sounds like, David, you indicated that that was a little more concentrated to the government or public sector vertical, but I just wanted to understand if there was any sort of concentration in that backlog or is it pretty similar to the metric you provide for your bookings.

You can presume it's similar to the metrics. And that's qualified by sort of the circumstances of the end of the quarter, which really aren't important. I mean if -- so we had some very large deals. A good concentration in our million dollar-plus order flow large deals. And some of those came in at the end of the quarter. And because they were large, we didn't ship them at the end of the quarter. And that will cause some concentration in the sectors in which those large deals came. They were both government, financial services and telecom deals, the largest of, our four largest deals.

So but you shouldn't read into the backlog, and so we're not really going to talk about it. Any significance from the fact that it happened to be a financial services deal that came in toward the end that we couldn't quite ship as opposed to a telecom deal or government deal, it doesn't -- it's not really indicative of the flow of orders throughout the quarter or the future.

Okay. And as it gets recognized, is that, again, maybe a similar split between product and services you have on the income statement? Or is that more oriented toward product revenue?

It will being more product revenue because that's what we put into backlog.

Okay.

So briefly, the way it works is we get in new service renewal orders, they go up into deferred revenue and we amortize them over the life of the contract. Backlog consists only of product orders. So that will all flow into product.

Understood. Okay. That's helpful. A follow-up question on the public sector strength. I don't know how much you can sort of add to this, but given it was their fiscal year-end, it did seem there were some dynamics for the spend around that. And I understand you probably want to be cautious due to maybe some uncertainty on the procurement side more than anything, but you did allude to the fact that you do expect continuation of modest federal spending.

So I'm just trying to understand as you build your outlook how much of this is sort of project work that you have pretty good conviction on to contribute in the back half relative to maybe not being so tied to the uncertainty around the procurement process.

Well, most of our federal business is in defense. And much of that is driven by programs that are ongoing, spending that is ongoing in support of deploying -- military deployments. Not all of it, but much of it is. And that tends to be a little more stable, a little less subject to the vagaries of variable funding and budget year cycle. We do see in the pipeline opportunities for the federal business to continue to flow even though the seasonality is against federal business in the near term, as well as perhaps the budget cycle.

But as you said, we are very cautious about the dynamics of the procurement process, and that's really the uncertainty that gives us pause as it did 90 days ago

Okay. And one last question if I could.

I haven't sort of gotten an update maybe on the telecom or wireless side. It seems like maybe looking at the AT&T numbers this morning their CapEx was right in line or maybe a little better than some people had feared. But in your conversations with some of the tier 1 carriers, are projects going on as planned?Has anything changed there, any more uncertainties?Maybe you can give us an update as to the opportunities within the tier 1s, please.

Yes. We see the tier 1 spend something continuing at pace and no significant changes vis--vis our plans. We see more -- more strength in the tier 2 compared to our expectation in particular international and cable MSO space so we saw some uptick in that area. But in general the telecom segment is going according to our plans overall.

Okay. And I don't want to tie you just to one particular device, but given your commentary about some more strength in the tier 2s, does that have to do with the iPhone being available by a broader number of carriers, is that helping the business on sort of the tier 2 level?

I can -- I can I cannot point to that as a major factor, I think it's more general, more generic than that.

In general it's the growth of smart phone traffic, whether it's iPhone or Android or other, iPad or whatever.

Understood. Thanks for taking my questions.

Thank you.

Your next question comes from the line of Matt Robinson with Wunderlich. Your line is now open.

Thanks and congratulations. Just a couple questions, well three, really. How did service provider bookings compare to the first quarter?

Hold one sec. New business bookings and service provider were up slightly from Q1. Total bookings were up about 10% sequentially.

Was there more of an overseas component or is it the usual suspects?

Our service provider business is growing faster internationally than it is domestically as Michael just suggested. And so I don't have the exact international content statistic here. But my general sense is faster growth internationally. Particularly in Asia.

Okay. In Asia especially?

Yes.

When you -- when you talk -- look at the financial services recovery, do you see that as more of a catch-up from a pause when people maybe tighten up the purse strings in recent months, or is there a more expansive pipeline along with it, as well?

So there is a good pipeline in financial services. The growth that we saw, the buying that we saw this quarter I think is -- is some customer-specific positives. As we suggested in the June quarter, there were some customer-specific absences in financial services. And that volatility we expect to continue. However, there is a good pipeline of financial services opportunities.

Speaking broadly in the long term, we all see, of course, the same headlines that -- that causes pause about the growth of financial services business opportunities, selling to financial services companies. But -- but we believe that there is a different quality to this than to the several year ago financial crisis where now most of the financial services companies or customers have things in view, if not visibly under control in all cases. But they are proceeding with -- with projects which will drive their competitiveness now, whereas despite the issues that they're dealing with, whereas three years ago, that really wasn't the case. Three years ago, they were pretty much on stop for new projects. And we don't think that's happening now.

So you think -- so it sounds like, and correct me if I'm interpreting wrong, but it sounds like most of the recovery was bringing things back into the order flow that had been delayed, but the results are some increase in your pipeline of opportunity.

It was things that didn't happen in June that did happen in September, yes. And it was new opportunities that were brought about by some of the new initiatives with some of our large customers, new business initiatives, so it was both.

Okay. So the other question I had was why did DSO go up?

It's mostly a factor of the skew, the back end load of the quarter. Which, of course, at the very back end of the quarter, we stopped shipping and built backlog. But still, we were back-end loaded in the quarter. There's nothing wrong with our receivables. Our receivables remain, to use an over the top word, stellar, best -- best than any company I've ever been in, large or small.

Okay. Well, good for that.

So you had a big September, but mostly in the first half, mostly the federal timing in September that drove that?

I'm sorry. Could you say that again, please?

Was most of the timing federal activity in September that drove the back end in linearity?

It was federal and financials, both.

Okay. Thanks a lot.

Okay.

Your next question comes from the line of Gary Spivak of Noble Financial Group. Your line is open.

Yes. Thank you, and I echo congratulations on the rebound this quarter. So if we take both quarters together and you look at -- you know, the financial sector, I think the commentary last quarter was, you know, people kind of pulling back, are you more inclined to say that it was limited to a few large deals? And if that's the case, what did you do differently this quarter? Or alternatively, did you see a big change in the backlog environment of the financial services this quarter?

Well, the short answer is we didn't do anything really differently. You know, the June quarter is always a weak quarter for us in terms of bring bringing deals home. And so we try to manage that. And sometimes we do well, and this June quarter we did less well.

So we didn't change anything. We didn't change our offerings. We didn't change our pricing. We didn't change our discounting. In fact, in this quarter, our discounting levels were improved over prior quarters and prior year.

We did have a sales incentive in place as part of our attempt to manage bookings in the first half. It was a six-month incentive, which we don't want to describe in detail, but it was -- but we think it was effective, and it timed out in September. That incentive was part of our effort, as I said, to manage some of the seasonality of bookings a little better. And it may have contributed some to that. We believe it did.

Okay.

Was that enough?

That's helpful, David. Thank you.

And then just on geography, obviously, it sounds like the strength was domestic. And it sounds like you've seen some strength in service providers internationally. But if you can comment on what you're seeing macro, particularly in EMEA -- but internationally in general.

We think EMEA is going to be troubled. Obviously our EMEA results were down in the quarter. And although most of our success in EMEA continues to be service provider driven and that buffers because they tend to be less driven by some of the economic macro cyclicality. But they are still affected by it. But many of our efforts to get in to broaden our appeal beyond service providers in EMEA may be slowed down by the European crisis that's going on.

On the other hand, in Asia, we continue to make good progress across a number of countries in the Rim and as well as in China,principally with carriers, wireless service providers, but also with Asian arms of multinational firms. So we are very upbeat about Asia, and cautious about Europe.

Okay. Thank you.

And then my final question is to the extent that government is part of the backlog heading into December, what -- is there a part of that that -- how do I phrase this, that government just couldn't process because they had so much backlog or were they basically able to get through the POs that needed to happen in that procurement process?I'm just curious what you saw.

They pretty much executed what we had expected. So the September quarter was a good government execution, I guess, on our part, as well as the government's part, as June was not so good. So we didn't -- it wasn't -- we have deals in the pipeline that obviously aren't in the backlog that didn't close, but we pretty much didn't expect them to close. You know, they're still available to -- for the December quarter and beyond. So it was a pretty on target execution with the high end of our expectations for the government.

Great. Thank you very much.

Thank you.

Your next question comes from the line of Rohit Chopra. Your line is now open.

David, just a few questions. On the renewals, can you give us a sense of whether that was concentrated in the government and were there any incentives this quarter on renewals to get those multiquarter renewals?

No. No. Neither -- it was neither concentrated, nor was there any special incentive. The incentive that I spoke about was only for new business, not for renewals. So the renewal strength was unaffected by that and was pretty much across the board.

The renewal -- any pulling from future quarter --

Right. Right.

This was mostly in quarter -- as Michael points out, mostly in-quarter renewal strength.

Okay. Can you talk a little bit about the competitive landscape?Michael I think you mentioned the Gartner report and I think I've seen that. But there must be 20, 30 competitors on that -- on that chart that they have.

And I just want to get a sense of the competition that you face these days. Has it increased, decreased? Are there more bake offs? What's actually happening there. There's a lot of noise out there about your sector these days.

Yes. Well, we do see more -- more competitive activity. And that's a good thing. That is the signal that NetScout's products are used in more ways and in different applications, different uses from our core network performance management origins. So we are expanding into application performance management, and that's -- you know, that's what's signified in that -- report.

But also, you know, that means that we are encountering competitive activity, and, you know, that's usually a very, very welcome development for us because it's part of how we grow and we show vigorous rebound in the enterprise and that's not just because of the cyclicality or tactical details of execution in Q1 and Q2 but the strength of our product -- in particular, Service Delivery Manager which is winning across the board. Service Delivery Manager has been with us for several years now, but it has been enhanced and evolved, and now we believe that it's taking the field across the board and winning -- winning against all of our key competitors. That's our assessment.

Michael, is there any change in the landscape for competition at the telco level? Is that causing any delays for you guys in winning some of these deals?

Well, there is a significant competitive dynamic in the telecom even more so than in the enterprise and, of course, the top competitor is of course Tektronix. And we do see and we do compete with them. And, in fact, it is a big factor in our -- in our sales success, how we win or lose, or whatever the case may be with Tektronix. That's a big factor, indeed.

And, yeah, as Michael said, yeah it's a big factor and there are a couple of other players also, second tier. But it has not changed significantly over the last few months or few quarters.

To be clear, there's nothing that -- nothing that's caused any delays recently, new competition hasn't caused any delays recently. Everything is the same as it was?

And -- and just to add, yes, not delaying, but a lot of tier 1 vendors are using multiple -- I mean are using product from multiple vendors. So even if there is a competition, we do some of the things differently than Tektronix and they do some things differently than us. And sometimes they end up buying both.

Okay. And then last question just on enterprise side I just want to get a sense of -- and Michael, you did mention some stuff about this. But just give us an idea about how the relationship with your partners is actually going. Are you getting revenue from Cisco, from HP? Can you just update us over there?

Yes. I mean we continue to have a -- a relationship with Cisco as the latest road show demonstrated, but I cannot ascribe significant revenues. There are some revenues coming from our ISR agent, you know, the agent that runs in Cisco's ISR routers and that really was the basis of the road show but it's not a material contributor. Under $1 million I would say, and I think it's more of a symbolic component of the relationship, and I don't expect the significant change in that going forward.

Okay. Anything on HP, any change there?

No major changes on HP

Okay. Thank you.

Your next question comes from the line of Ben Abramovitz with Kaufman Brothers. Your line is now open.

Good morning.

I just wanted to go back, I think someone asked it earlier, I'm trying to get a little more color around the Psytechnics acquisition and some of the new products that were rolled out in the quarter and how that may have helped -- I know you talked about it marginally. But if you can give us a little more color about how that is helping to contribute to some of the revenue growth and product growth and how that might play out in overall contribution for the year.

And then question two -- if you can help us think about if we're looking out at the marketplace at some of the 4G deployment and we view network takeups by the end users a little bit slower, how to translate that back, do you -- because -- if we look at it from the outside, we're trying to understand how much capacity utilization has to be on the networks before the carriers come back for incremental product from you.

So I think that -- it looks like two related questions the Psytechnics acquisition, as David was saying, is having some contribution and even though we don't disclose it, and it is tracking to what we expected when we give the guidance in April.

And in general, what people are looking for is they're looking for devices or products or a probe which can look at data, combine data and voice and video on the same link or the same network. And we have only product on market with that acquisition of Psytechnics and we have basically taken their probe and embedded the software in our probe. And a lot of existing customers are very interested.

So the success there is from the old pipeline of Psytechnics, but most of it is because of how we are delivering this product and the total cost of ownership and using one probe versus two probe. So those are all the factors in our success and it's tracking well and we think it will be even better next year.

As to 4G, it was not clear, I mean what you are trying to get. But I mean there is a lot of business to be done on 3G also. And so in the 4G or 3G area, either way let's say you roll out more iPhones, then you create more phone zones, which is almost like create ago new environment for our product. So there is a lot of growth coming all over the place, 3G and 4G, and I don't know whether you are asking how it's there for Psytechnics. Right now it's more of an enterprise play but we think the technology will be useful eventually for the service provider also.

Okay. I guess what I was trying to get at, you're right. There were two separate questions. What I was trying to better understand in terms of when you're selling to the carriers, how you look at that sales cycle in terms of what the key driver is for them to come to NetScout for additional product over time.

I think it's basically understanding what's going on on the network. Because I mean they're rolling out bandwidth, but bandwidth doesn't solve all the problems. So as they're rolling out -- they're used to instrumenting their network on the analog world. So as they're converting more and more of the network to IP or digital, that's where the investment is coming from. So interestingly, in the enterprise area we have to prove why you need intelligence like us for some of the accounts.

And service provider that is not an issue. They already understand the value of what we do. And they -- I mean they need our product if they are going to move it into IP.

So there we have some competition, but as Michael said on Tektronix side, and so basically what is going on is people are expanding their networks, data centers, phone zones, converting various portion of the network from analog to digital or cellular to IP, and that creates opportunity for us to provide visibility on those links which were available from phone companies in the analog world but it can only be done through a product like us in the digital world.

Ben, once you may be asking what the impact -- we expect the impact of 4G roll outs to be on our business volumes, and as Anil said, to focus on that, if that was the question. 3G is -- today is a much bigger driver over volumes than is 4G. And as investment transitions from a carrier from 3G to 4G we will go there too. It's less an issue of is there an inflection driven by a big 4G investment for us. It may be true for some infrastructure players that sell 4G specific products but our products work both places.

That's what I was looking for.

Yes. So it's really -- as Michael just mentioned, it's really the growth of data. And as Anil mentioned, it's the conversion of and a log to digital and the movement of traffic to digital that creates more opportunity for us, whether it's 3G or 4G.

Thank you.

Any other questions, Ben?

Your next question comes from the line of Kevin Liu. Your line is open.

... the pipeline of large deals as you move into the back half of the year? And then also on NVVM, I'm just curious as to what sort of -- how much of the pipeline is comprised of that product and what sort of uptick you expect there, whether it should be a more gradual build throughout the year or whether it should be a rather steep growth trajectory?

Can you repeat the beginning of your first question, please? I didn't hear it.

I was just curious of the pipeline of large deals since you closed so many in the second quarter here.

So our pipeline remains very healthy and there is a significant amount of large deal content. And our pipeline and our bookings have been swinging more and more and more toward large deals because we're becoming more strategic to big buyers in telco and government.

Not to go back too far, but five years ago, we didn't have much government business and we had no telco business, and that's all new incremental business and big deal focus business for us in both markets. So you should expect that to continue, although some of the tier 2 carriers around the globe will be less big than some of the tier 1 carriers we dealt with first. So the pipeline is healthy for the second half of the year.

In terms of NVVM, we have been seeing a good growth. It's a nice growth of the pipeline. So part of that -- the NVVM deals are not large like we see with the carrier, the telcos and the government deals, they tend to be smaller deals, what we call beachhead deals, with new customers or incremental add-ons to existing implementations with our current customers. And since it's a new product and a new technology, those deals, as always happens with our product sales, tend to be smaller. So the pipeline is good, but it's not a major contributor to the overall pipeline size.

Got it. And just switching gears to the thoughts on the Replay acquisition for a second, do you have your customer base already asking you to provide security products in conjunction with your MPM offerings?

Yes. Basically there are two markets for this product. One is lawful intercept and there we don't have anything in the pipeline now. But Fox Replay has a small pipeline for that.

The second use is just taking data from our listening devices called probes and providing a view on what's going on, what the user saw which we call session -- and session reconstruction or actually being voice and things like that,voice traffic social networking and things like that. So there is an interest with few customers who have been asking for. And we had a prototype of a test product before this, and but they were looking for a more formal product in this area. So obviously, they will be very happy in looking at this and basically it will be a plug in directly to the existing instrumentation they bought from us in the last year or so.

And just lastly, you know, we've seen two acquisitions in the past two quarters here. I'm just curious what else you have in the acquisition pipeline or whether we should expect the pace to slow now.

Obviously we have to digest all this before we do more. But we are continuing look at these acquisitions and because of the recent activity in our site, we get a lot of calls from other companies so we don't really need to look around for companies. That are a lot of companies who want to be partner or acquired by NetScout. So yeah there is activity going on and we don't want to do too many this year, but we are not sure right now whether any more will happen this year.

Okay. Thank you.

Your next question comes from the line of Scott Zeller from Needham. Your line is now open.

Thank you. Good morning. I wanted to first ask if there were any 10% customers in the quarter.

We think there might be have been one. We'll research that and let you know. We can't give you the name, of course, but we'll let you know.

Would that have been just at the 10% threshold or would it have been materially above that, you think?

No. It would not have been materially above that. We're checking.

Okay. There have been several questions on the product backlog. But I wondered, and we talked about the vertical composition of it. But could you talk about any sort of dynamics around customization needs, perhaps, of those deals that would perhaps change the timing of revenue?

Are you talking about the service provider area or --

Yes. Yes.

Yes. There is customization because there are RFPs for additional work as part of our product. But not specific customization for each customer. Although we have seen some minor things we could do with the product but it's not a significant effort. So customization by user or customer is not required really to win the business.

And I just want to add one more thing that even though people are buying 3G, mostly 3G products from us, they really want to see the 4G road map. So 4G road map still drives the 3G -- impacts the 3G business. So in that sense, it is only really no customization. But there are enough things to do for us to deliver the full product.

So based on that, just to follow up, would there be any -- I mean would there be a scenario where some of these deals and backlog would be taken over time or would we expect them to be recognized in larger chunks?

No. Those deals are essentially all shipped now and taken to revenue now.

Okay. Thank you.

Your next question comes from the line of Dan Cummings with Think Equity. Your line is now open.

Thanks very much. I apologize if you gave this color before.

David, last quarter, you had indicated that the pressures that you saw in the financial services were very concentrated at the largest banks. So I guess I would love to know the success that you had in the September quarter, was it broader also or similarly concentrated? And then just a question on the business development expense, how much more before that runs out?Thanks very much.

Okay. So the financial services business for us, our success we had, was relatively concentrated, as much of our financial services, you know, volatility is. And in June, we didn't have a big deal, and in September we had a very healthy sized deal, as well as a good array of smaller financial services large deals. So -- so financial -- our financial services business tends to be concentrated amongst the players who are really trying to push their infrastructure. And that's where obviously our value is the greatest and where the uptick of our product is the greatest.

And that continued to be the case here but there was a significantly large deal and a handful of large but somewhat smaller deals. Does that answer your question?

That's perfect.

And the business development, the nonrecurring expense. How much more -- are you amortizing something there? Should we expect to see that again in the second half?

The business development is non-GAAPed out of our non-GAAP results. And you should expect to see things continuing, intermittently,right?From time to time, we will be active in searching for or trying to close acquisition deals, and we will non-GAAP out the business development expense. But it does not go on the balance sheet and it's not amortized, it's not capped, it's non-GAAPed out.

Thank you.

In answer to the earlier question about 10% customer, we had no 10% customer in revenue. We had one 10% customer in receivables at the end of the quarter.

There are no questions at this time. I turn the call back over to David Sommers.

All right. Well, thank you all very much for attending our call and for a good array of questions. We appreciate them, and we look forward to speaking to you again at the end of our third quarter in -- in January, about 90 days. Have a good day.

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