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spk07: Ladies and gentlemen, thank you for standing by and welcome to NETSCOUT's second quarter 2021 financial results conference call. At this time, all parties are in a listen-only mode until the question and answer portion of the call. As a reminder, this call is being recorded. Tony Piazza, Vice President of Corporate Finance, and his colleagues at NETSCOUT are on the line with us today. If you require operator assistance at any time, please press star zero. I would now like to turn the call over to Tony Piazza to begin the company's prepared remarks.
spk01: Thank you, Operator, and good morning, everyone. Welcome to NETSCOUT's second quarter fiscal year 2021 conference call for the period ended September 30, 2020. Joining me today are Anil Singhal, NETSCOUT's President and Chief Executive Officer, Michael Zavados, NETSCOUT's Chief Operating Officer, and Jean Bua, NETSCOUT's Executive Vice President and Chief Financial Officer. There is a slide presentation that accompanies our prepared remarks. You can advance the slides in the webcast viewer to follow our commentary. Both the slides and the prepared remarks can be accessed in multiple areas within the investor relations section of our website at www.netscout.com, including the IR landing page under financial results, the webcast itself, and under financial information on the quarterly results page. Moving on to slide number three, today's conference call will include forward-looking statements. These statements may be prefaced by words such as, anticipate, believe, and expect, and will cover a range of topics that are not strictly historical facts, such as our outlook, our market opportunities, and market share, key business initiatives, and future product plans, along with their potential impact on our financial performance. These forward-looking statements involve risks and uncertainties, and actual results could differ materially from the forward-looking statements due to known and unknown risks, uncertainties, assumptions, and other factors. which are described on this slide and in today's financial results press release, as well as in the company's annual report on Form 10-K for the year ended March 31, 2020. NETSCOUT assumes no obligation to update any forward-looking information contained in this communication or with respect to the announcements described herein. Let's turn to slide number four, which involves non-GAAP metrics. While this slide presentation includes both GAAP and non-GAAP results, unless otherwise stated, financial information discussed on today's conference call will be on a non-GAAP basis only. The rationale for providing non-GAAP measures along with the limitations of relying solely on those measures is described on the slide and in today's press release. These measures should not be considered in isolation from or as a substitute for financial information prepared in accordance with GAAP. Reconciliations of all non-GAAP metrics with the applicable GAAP measures are provided in the appendix of the slide presentation in today's earnings press release, and they are also on our website. I will now turn the call over to Anil for his prepared remarks. Anil?
spk04: Thank you, Tony. Good morning, everyone, and thank you for joining us. Let's begin on slide number six with a brief recap of our second quarter non-GAAP results. We delivered solid earnings per share growth on lower revenue of $205.3 million compared with the same quarter last year. Earnings per share was $0.38 in the quarter, an increase of more than 35% compared with the same period last year. Both service provider and security revenue grew in the quarter, but were more than offset by a decline in spending in the U.S. federal government sector, which impacted enterprise revenue. The quarter benefited from a focus on cost control as well as pandemic-related travel restrictions. Let's move to slide seven for some further perspective on the business. In the service provider vertical, revenue grew 4% compared with the same quarter last year. We continue to work with our service provider customer on the 4G LTE evolution project internationally and on their 5G project domestically and in certain Asian regions. Given that 5G build-out is one of our catalysts for future growth, I want to provide some insight into where we see the market right now and how it may evolve. Currently, many North American carriers have 5G offering utilizing their 4G network. These services are operated on what is called non-standalone 5G network. Over time, carriers and others will need to build new standalone 5G networks to support future use cases and ultimately a larger volume of traffic. These standalone 5G networks will be software or virtual installations, given that they will be more distributed at the edge in order to deliver on the promise of enhanced bandwidth, higher speed, and low latency to support 5G use cases like industrial automation, telemedicine, autonomous transportation and drones, augmented and virtual reality gaming, and the Internet of Things. Last year, we discussed a few projects we want related to the radio frequency propagation modeling or calibration, which is a precursor to 5G as the providers plan out their network based on signal data collected. From NETCorp's perspective, although we participate in all phases of 5G evolution from planning, development, deployment, and monitoring, we believe that we'll see the largest benefit once the standalone networks are deployed and traffic is flowing over those networks. Therefore, we see 5G as a bigger revenue opportunity for our next fiscal year and beyond, yet a major R&D investment now. In the short term, our 5G roadmap, investment, and leadership will be one of the key enablers for securing our income and for driving our 4G user plane monitoring business. Michael will highlight some of this quarter's service provider customer wins during his remarks. In the enterprise vertical, revenue declined approximately 14% over the same quarter last year. This was primarily attributable to lower spending in the federal government sector in our second quarter, which declined more than 60%. As we have previously mentioned, despite having a solid pipeline of user-approved projects in the federal government sector, the timing and magnitude of funding for these initiatives has been challenging to predict in the current environment. Removing federal government revenue from the comparison, enterprise revenue would have grown in the low single digits in the quarter. Even with this quarter's decline in enterprise revenue, the vertical has grown 1% year-to-date, and strong performance in our security offerings helped offset muted federal government spending. In this vertical, customers continue to advance their digital transformation, cloud migration, and security initiatives, initiated with even greater urgency as a result of the pandemic and the new normal of operating with remote resources and interacting with their customers in a more virtual fashion as they work to address speed, agility, and cost. On the security front, the threat landscape continues to evolve rapidly, and the pandemic has created more opportunities for bad actors to disrupt organizations given their distributed operations. Last month, we issued our first half 2020 threat intelligence report, which highlighted how cyber criminals are exploiting the pandemic through a radical change in the DDoS attack methods they are using. The report discussed how cybercriminals launched record-breaking DDoS attacks on online platforms and other services crucial during the pandemic and in increasingly connected worlds. These attacks targeted e-commerce, education platforms, financial services, and healthcare services. These multi-vector attacks were shorter, faster, hard-hitting, and more complex. These new methods put pressure on security teams as they have less time to react to defend their organization system, making the job much more difficult and highlighting the need to have strong DDoS detection and mitigation solution like ours. This dynamic has certainly played an important part in the strong performance of our security solution in the quarter and year to date. Michael will highlight some of our enterprise events related to these trends during his remarks. Now let's move to slide number eight, to the reviewer outlook. Our business and operations have proven to be largely resilient as we navigate the global pandemic and macroeconomic uncertainty. This is due to our relevant solutions, trusted brand, strong customer relationship, dedicated team, and solid financial profile. That said, we are not immune from the impacts of COVID-19 global pandemic. As we evaluate the outlook for the remainder of the fiscal year, we remain cautious given the uncertainty around the pandemic and the resulting macroeconomic environment. These dynamics have caused elongated purchase cycles, making timing, magnitude, and funding for deals difficult to predict, which we anticipate will negatively impact our traditionally strong second half of the fiscal year financial results. As a result, we now expect fiscal year 2021 revenue to decline in the mid to upper single digits on a percentage basis compared with fiscal year 2020. Despite the revenue decline, we are committed to delivering annual non-GAAP earnings per share in line with our fiscal year 2020 non-GAAP earnings per share as we continue to prudently manage our cost structure. In closing, we are pleased with our ability to serve our customers' visibility and security needs while ensuring the safety and productivity of our team as we attribute our success and deliver stable results in this tough and uncharted COVID-19 environment. We appreciate the continued dedication and support of our employees and other stakeholders as we navigate the global pandemic. With long-term market trends in our favor, such as digital transformation, cloud migration, increased cyber threats, and 5G networks, Nextot is well positioned as guardians of the connected world when we emerge from this global crisis. I look forward to sharing our progress with you as the fiscal year continues to unfold. I will now turn the call over to Michael Lentz for his remarks.
spk05: Thank you, Anil, and good morning, everyone. Slide 10 outlines the areas I will cover. First, with custom movements. Starting with customer wins, as Anil mentioned, our service provider Vertical has solid growth in the quarter as we continue to see 4G expansions in our international customer base and 5G trials in North America as we await the 5G investment cycle to kick in. A notable internal 4G win in the quarter was a multi-year eight-figure software and support deal for a major European carrier, a long-standing loyal customer that provided mid-seven figures of revenue in the quarter. The investment enables the carrier to expand their 4G capacity and positions them to transition to 5G solutions in the future. On the 5G front, we want a low- to mid-seven-figure user trial with a Tier 1 North American carrier as they start to explore a standalone so-called 5G network. It is still early days for North American standalone 5G visibility projects, but this is a good sign for progress. All these demonstrate the trust in our brand, the strength and value of our solutions, and the importance of our incumbency with our loyal customer base. In the enterprise vertical, service assurance solutions have continued to be highly relevant and are producing important new logos for us in the financial, healthcare, and other sectors. During the quarter, one new logo and deal we won was with a large domestic medical provider with over 1,000 beds and more than 1.5 million patient visits annually. This was a low-to-mid seven-figure deal to implement our visibility platform in a fully virtualized deployment with extensions into the cloud for this provider's patient management system. The scale and completeness of our solution as well as the expertise of our team won us the deal over multiple competitors with partial solutions. On the international front, Another new logo and competitive win was a low seven figure deal with a major stock exchange that needed a faster and more reliable solution to triage and troubleshoot application problems. They selected our service assurance solution because of our rich data source and strong analytical capabilities which solved their challenges as we replaced a major competitor's solution that was falling short from their expectations. In both of these cases, we secured these new customers as a result of our reputation as a trusted leader in service assurance with innovative and reliable solutions. But we have also identified TIDAS opportunities to expand these relationships in these deals as we leverage our cross-selling capabilities to our integrated sales team. On the security front, it spans both the service provider and enterprise verticals. we continue to experience growing interest in our DDoS protection, especially as the sophistication and volume of attacks grow quickly, as we outlined in our first half 2020 threat intelligence report, which Anil referenced earlier. During the quarter, we successfully thwarted extortion attacks on large U.S. customers, prompting even more attention on this space and on our solution set. This level of protection requires on-premise deployment, such as our Arbor Edge defense solution, both for rapid responsiveness and sophisticated Layer 7 protection. The demand for our AED-based solutions have increased due to the large customers redesigning their infrastructure, now settling in for remote work for the long haul after the initial rush to shore up defenses when the pandemic started. This trend is exemplified in a mid-six-figure deal with a large insurance company domestically and a low seven-figure deal with a leading international stock exchange. We are excited about our ability to provide these solutions to our customers through a well-trained, unified worldwide sales force. In terms of go-to-market activities, we continue to build our brand on a strategically critical level partner to leading virtualization and cloud providers. In October, we participated in the annual VMworld event as a technology alliance partner. There were more than 150,000 participants that joined the virtual event over the 10-day duration. We presented and showcased our advanced applications, performance management, and troubleshooting capabilities in VMware's virtualized on-prem and AWS cloud deployment. Also, recently our AWS migration ISV partner competency has been approved by AWS, meaning that AWS certifies to customers that NASCAR has been vetted, validated, and verified against the high board, and that AWS will promote NASCAR through the AWS sponsorship program. On the security front, during the quarter, Antia, a global research leader in technology, ranked Nelscap Arbor as the top and largest vendor in the DDoS market, highlighting our new security investments and our visibility. and threat analytics. Finally, as a leader in our industry, as earlier discussed, in September we published a semiannual threat intelligence report. Our report was picked up by approximately 50 publications and translated into five languages, as our threat intelligence report is considered an industry-barrier report. That concludes my prepared remarks, and I will now turn the call over to Gene.
spk06: Thank you, Michael, and good morning, everyone. I will review key second quarter and first half fiscal year 2021 metrics and our outlook. As a reminder, this review focuses on our non-GAAP results unless otherwise stated, and all reconciliations with our GAAP results appear in the presentation appendix. Slide number 12 details our results for our second quarter and first half of fiscal year 2021, focusing on the quarterly performance revenue decline 5.1%, over the same quarter in the prior year to $205.3 million. Product revenue declined 10.5%, and service revenue declined 0.3% over the prior year's quarter. Our second quarter fiscal year 2021 gross profit margin was 74.7%, down 1.9 percentage points over the same quarter last year due to product mix, most notably increased radio frequency propagation modeling project revenue with much lower gross margins. Our software-only sales were 27% of service assurance product revenue compared with 20% in the second quarter of the prior year. Quarterly operating expenses decreased 15.4% from the prior year, primarily due to continued cost controls and pandemic-related travel restrictions. We reported an operating profit margin of 19.4% compared with 14.6% in the same quarter last year. Diluted earnings per share was 38 cents compared with 28 cents in the same quarter last year. Turning to slide 13, I'd like to review key revenue trends for the first half of the year. For the first six months of fiscal year 2021, the service provider customer vertical revenue declined approximately 8%, while the enterprise vertical grew approximately 1%. The service provider and enterprise verticals each contributed approximately 50% to total revenue for the first six months of this fiscal year. Turning to slide 14, which shows our geographic revenue mix on GAAP's basis, Revenue by geography was 58% in the United States and 42% internationally. There were no customers in the quarter or the first half of the year that represented 10% or more of revenue. Slide 15 details our balance sheet highlights and free cash flow. We ended the quarter with cash, cash equivalents, short-term marketable securities, and long-term marketable securities of $427.8 million. which is an increase of $1.3 million since the end of the first quarter. Free cash flow generated in the quarter was $8.3 million. We did not repurchase shares of our common stock during the quarter. From a debt perspective, as of the end of the second quarter, we had $450 million outstanding on our $1 billion revolving credit facility. We had approximately 1.5 times cushion against our growth leverage covenant, providing potential borrowing capacity if needed. Our revolving credit facility expires in January of 2023 and has no required principal repayments until maturity. To briefly recap other balance sheet highlights, accounts receivable net was $169.7 million, down by $43.8 million since the end of March. DSOs were 65 days versus 73 days at the end of fiscal year 2020, and 79 days at the same time last year. The improvement in the DSOs in the second quarter of this year compared to the second quarter of the prior year is primarily attributable to the timing of orders within the quarter. Moving to slide 16 for our outlook from a non-GAAP perspective, as Anil stated in his remarks for fiscal year 2021, we expect revenue to decline in the mid to upper single digits on a percentage basis compared with fiscal year 2020. Despite lower revenue, we anticipate delivering annual earnings per share in line with our fiscal year 2020 earnings per share number as we continue to prudently manage our cost structure. For the second half of the fiscal year, we anticipate that the remaining earnings per share performance should be more equally distributed between our third and fourth fiscal quarters than it was in the prior fiscal year. Given the current pandemic conditions and our cost management focus, we anticipate that our third quarter operating expenses will be in line with our second quarter operating expense results. I also want to comment on a few capital structure related items for fiscal year 2021. We expect the tax rate to be approximately 23%. Additionally, we expect the dilute shares outstanding for the year to be approximately 74 million shares. That concludes my formal review of our financial results. Before we transition to Q&A, I'd like to quickly note that our upcoming IAW conference participation is listed on slide 17. I'll now turn the call over to the operator to stop Q&A.
spk07: At this time, if you would like to ask a question, please press star 1 on your touchtone phone. If you wish to remove yourself from the queue, press the pound key. We do ask in the interest of time that you limit yourself to one question and one follow-up. We'll take our first question today from Kevin Liu with K. Liu & Company. Your line is open.
spk03: Hi, good morning. First question here is for You talked about some of the deals elongating. I was wondering if you could elaborate more so just in terms of what you're actually seeing in terms of pipeline building. Have you still been able to grow that both on the enterprise and service provider side? And then just from the perspective of deals pushing out, you know, if we kind of put the government vertical aside, what exactly do you think your customers are waiting for in order to move forward with some of these opportunities?
spk04: Thanks for the question, Kevin. So I think there are two areas. One is certain industries where there is unpredictable timing of whether they go with certain projects in the pipeline. And I would put on the top of that is hospitality industry and the federal government. A lot of uncertainty around that. So that's factor number one. The second one is elongated sales cycle, and those are in two buckets. One is we release some new products, especially in the security space, and normally during the purchase cycle, we have to evaluate them, and that requires somebody to go in and install that, and that has been difficult, and that extends the sales cycle. And second thing is people who are new logos, even though we had some successes, there's a lot of interest in our new software-based offerings, especially in the enterprise. But new logos who are the first-time buyers also has to go through the cycle of verification and trials, and that has slowed down. So those are the factors which are mostly all COVID-related and which we're certainly counting on this year, which has changed.
spk03: Got it. And then just quickly, in the past you've talked about enterprises kind of emerging as an interesting opportunity for 5G. Are you still seeing that trend build out? Anything you can talk about in terms of how large of an opportunity you see that over the coming years?
spk04: I see that as a fall-on opportunity. So if you, as Gene talked about, I think in the last year and partly this year for some revenue, we see some pre-deployment opportunities like calibration, which are small and but that's where we are then next step will be carriers using our 5g solution for user plane monitoring and we are in the early phases of that and much later than that will be carriers participating in private 5g because cloud vendors and the carriers will have to lead those efforts also. So I see that as a more private 5G and more of a longer-term opportunity than the carrier 5G.
spk03: Sorry, that's helpful. Thank you for taking the question.
spk04: Sure.
spk07: Our next question comes from James Fish with Piper Sandler. Your line is open.
spk00: Hey, guys. Glad to hear you're all doing well. On the security side, years ago, your carrier customers bought additional capacity, and now we're starting to hear from you guys that we're seeing larger and more attacks. Are we starting to get to a point where these carrier customers are going to need to add more capacity with Arbor?
spk04: I think they have – I mean, they will need, but I think they have quite a good capacity. I think when we talk about security, there are two products which we have. One is for the service provider side and other is for the enterprise side. We see the NETSCORE being a much bigger enterprise business versus iBird. We have seen a lot of opportunity in that area with a product called AED, which basically looks at application layer attack, which is a new set of attack vectors It's an on-prem device or it's an entry to the cloud. And when it gets into trouble, it signals to Arbor Cloud. So that's a big area of growth we are counting on, and we have released a couple of solutions and started the go-to-market initiative, which has been sort of slowed down because of people not being able to do speedy trials. So while we see some steady-state business on the carrier side, the growth area for security is DDoS for the enterprise with application-led attack focus, layer-7 attack, and a new product we had announced at our user conference called Genius Cyber Investigator. So those are the things we see more opportunity through those products in the enterprise sector. And then sometime next year, similar functionality will be needed for mobility providers, both for 4G and 5G. And those are the things. So those are somewhat different than the past average revenue growth area of more capacity in the carriers.
spk00: Got it. And then, Jean, for you, can you give us some color within Arbor across enterprise and carrier like you typically do? And also, you know, Billings appeared fairly strong. Was there a good amount of product backlog that should give us some confidence here that our trends could be a little bit better than you're expecting? Or were you just seeing greater attachment of additional services?
spk06: So Arbor, for Arbor, I guess we can talk about the year-to-date arbor. Year-to-date, generally, a service provider had a good second quarter and probably a slap on a year-over-year basis. In enterprise, for the year-to-date, they grew very strongly. They grew on about a 30% increase. And it's mostly in the areas where they again, play to very large institutions like financial institutions or the government. They continue to do well in Auburn given the DDoS and the security nature. They are better because of the integration of the sales force. They have many more opportunities now with the service assurance. and any of the issues that they had, you know, more than a year ago with understanding their territories are behind them. So, obviously, it's done pretty well for the first half of this year.
spk00: And then on the billings being kind of stronger, I mean, is it more product backlog than normal, or was it, you know, greater attach of additional services this quarter?
spk06: Oh, it's all – let me just check one second. It's mostly – I would say it's mostly product. When I look at it, the product grew very strongly in Q2 and is, you know, on an okay growth rate for year-to-date also.
spk00: Got it. Thank you.
spk06: You're welcome.
spk07: Again, that is star and one for your questions today. We'll go now to Eric Martinuzzi with Lake Street. Your line is open.
spk02: Just a clarification on the full-year revenue guide. I want to try and put some numbers around the mid to upper single digits. Is this down 5% to 8%, down 4% to 9%? Do you have a preference between those two?
spk06: I guess I would say I always think of mid digits as 4% to 6%, and then the upper single digits as 7% to 9%. So my range would be four to nine.
spk02: Okay. Great. And then on the Fed, you know, historically the September quarter would be a good quarter for NETSCOUT with the federal business. Are we looking at something that's just, you know, vagaries of being a sub to the main, you know, where it's just lumpy? Or is this potentially killed projects? Is it pending new appropriations? Could it snap back in December, or are we looking at a multi-quarter issue in your view?
spk04: I think it could be a longer term. I don't think it's going to snap back in December. And in federal government, we have seen projects, even without COVID in the past, they never die. They just sometimes last for two years. So I think that the budgets are approved. We have the selected partner, but something magically changing in the fiscal year, I think, is unlikely.
spk02: Okay. All right. And your commentary on the non-GAAP earnings for the business, you guys have always done a good job on the cost management. You've done a good job of being able to hit your non-GAAP earnings targets on an annual basis. You did see a decline in Q2 of I think it was 15% or 16% in the operating expense. I've got to believe part of that is just less T&E, less conferences because of COVID, but what are our cost structure points of leverage as you're trying to manage to that non-GAAP EPS target?
spk06: So the first one would obviously be the condition of the pandemic and the amount of travel that the sales force will do. In Q3, I don't view them doing incrementally more travel than they did in Q2. The other levers that we have for the rest of the year generally are headcount, the backfilling of any attrition, or there are certain investment areas that we'd like to make in sales, whether we continue with that investment or delay that investment. And then one of the other larger levers goes down to basically variable incentive compensation. which is in the form in the sales force, obviously, of commissions, which is a function of revenue, or for the rest of the employee population, the incentive compensation that comes with the achievement of earnings per share targets on an annual basis and the resources available to achieve those earnings per share.
spk02: Gotcha. And last question for me comes to the services revenue. Historically, we would see an uptick here, but this is, you know, we're not... I guess we are in historic times. We're certainly not in normal times. You had a negative comp in the services revenue in Q2, and I would guess based on the product sales in the prior quarters, we're probably looking at negative comps in Q3 and Q4 on the services revenue. Can you give us some insight on Q3 services revenue? Sure. Is that up sequentially, or is your expectation that it could, in fact, be down sequentially?
spk06: I would say service revenue is fairly baked in, which is why we're generally very accurate on that forecasting service revenue. I would say when I look at our models, let me just look at one thing first. I'm looking at the midpoint. I would say service revenue looks like it's going to be relatively consistent with the service revenue that we achieved in FY 2020. You know, as you point out, Q2 of this year compared to last year was actually pretty flat. Last year had about a $2 million catch-up of revenue due to a later signing on a renewal. But for the full year, I would look and estimate that service revenue will be generally flat to last year's level.
spk02: Great. That's helpful. Thanks for taking my questions.
spk06: Thank you, Eric.
spk07: And it does appear that we have no further questions at this time. I would now like to turn the call back to our speakers for any additional remarks.
spk01: That concludes our call for today. We appreciate everybody joining us and have a great day.
spk07: That concludes today's program. Thank you for your participation. You may disconnect at any time.
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