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spk03: Please stand by, your program is about to begin. Should you need audio assistance during today's program, please press star zero. Ladies and gentlemen, thank you for standing by and welcome to NETSCOUT's second quarter fiscal year 2023 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, Senior 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.
spk00: Thank you, operator, and good morning, everyone. Welcome to NETSCOUT's second quarter fiscal year 2023 conference call for the period ended September 30th, 2022. Joining me today are Anil Singhal, NETSCOUT's President and Chief Executive Officer, Michael Zabados, 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. Examples of forward-looking statements include statements regarding our future financial performance or position, results of operations, business strategy, plans and objectives of management for future operations, and other statements that are not historical facts. You can identify forward-looking statements by their use of forward-looking words such as anticipate, believe, plan, will, should, expect, or other comparable terms. We caution listeners not to place undue reliance on any forward-looking statements included in this presentation which speak only as of today's date. These forward-looking statements involve risks and uncertainty, and actual results could differ materially from the forward-looking statements due to known and unknown risks uncertainties, assumptions, and other factors, including but not limited to those described on this slide and in today's financial results press release. For a more detailed description of the risk factors associated with the company, please refer to the company's annual report on Form 10-K for the fiscal year ended March 31, 2022, on file with the Securities Exchange Commission. NETSCOUT assumes no obligation to update any forward-looking information contained in this communication or with respect to the announcements described herein. Let's now 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 detailed on this 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 on our website. I will now turn the call over to Anil for his prepared remarks. Anil?
spk01: Thank you, Tony, and good morning, everyone. Welcome and thank you all for joining us today. Let's now turn to slide number six for a brief recap of our non-GAAP financial results in the second quarter and the first half of our fiscal year 2023. Focusing first on the second quarter of fiscal year 2023, we delivered strong financial results, and drove progress across our strategic growth priorities during the quarter. Importantly, this included further expanding our cybersecurity business. Second quarter revenue was $228.1 million, representing year-over-year growth of nearly 8%. Our revenue expansion was driven by 10% product revenue growth and more than 5% service revenue growth, both on a year-over-year basis. Of note, our cybersecurity and service assurance product line continue to grow in the quarter on a year-over-year basis. With this revenue growth and our healthy operating leverage, we delivered $0.50 per diluted share in the second quarter of fiscal year 2023, representing diluted earnings per share growth of approximately 21% year-over-year. Now moving on to the first half of fiscal year 2023. During the period, revenue was $436.9 million, growing by nearly 9% year-over-year. This increase was driven by product revenue growth of more than 14% and service revenue growth of nearly 4%. During the same period, cybersecurity revenue grew by 14%, while service assurance revenue grew by more than 6%. All comparisons are on a year-over-year basis. We delivered 81 cents of diluted earnings per share in the first half of the fiscal year 2023, representing diluted earnings per share growth of approximately 21% year over year. Now let's move to slide number seven for some further perspective on marketing, market and business insights. Starting on the cybersecurity front, we recently released our DDoS threat intelligence report for the first half of 2022. In it, we highlighted many of the current trends and challenges within this critically important area. Our report findings demonstrate how adept and sophisticated cyber criminals have become at leveraging new DDoS attack vectors and their other methodologies to attempt to bypass organizations' defense measures. The report also highlighted the significant geopolitical implications of today's DDoS attackers. In short, many of these bad actors are openly embracing online aggression to cause disruption and geopolitical unrest through the high-profile DDoS attack campaigns. Equipped with our state-of-the-art platform for increased visibility and defensibility, we play an important role in this ecosystem and remain confident in our ability to help customers navigate these challenges while also capitalizing on the opportunities of today's digital world. In line with these strengths, Our OmniSuite of cyber intelligence product has continued to gain traction, although it still only accounts for a small portion of our revenue stream. During the second quarter, for example, one of our large customers continued to integrate with the NETSCOT platform by incorporating OmniSuite into the current installation base. Additionally, we continue to innovate in the cybersecurity area, introducing new solutions like Arbor Insight to help address the evolving threat landscape. When combined with Arbor Sightline, this solution can dramatically enhance and extend a company's capabilities in threat detection, service delivery, and network operator visibility. Now let's turn to our customer verticals for more business insights, starting with our service provider. Service provider revenue increased by 11% year over year in the first half of fiscal year 2023. This increase was primarily driven by higher revenue related to radio frequency propagation modeling projects from Tier 1 carriers in North America. Importantly, we continue to see carriers invest in their 5G deployment, both for planning purposes as well as for standalone build-outs, where the same carriers also are starting to deploy commercial traffic. In our enterprise customer vertical, revenue grew by approximately 6% year-over-year in the first half of fiscal year 2023. This top line expansion was driven by growth in both our cybersecurity and service assurance business line as enterprises continue to demand best-in-class cybersecurity solution as well as visibility solutions capable of helping them to better protect their systems and facilitate the acceleration of their digital transformation. In addition, we are leveraging our growing set of comprehensive solutions to execute a platform approach, which is also starting to resonate with customers. Michael will provide more insight regarding customer wins within our verticals during his remarks. Now let's move to slide number eight to review our outlook. Looking ahead, we plan to continue managing our operations prudently, taking a balanced approach to revenue growth and profitability. Overall, we recognize the current uncertainty in the macroeconomic environment. We also remain confident about our business prospects and are excited about the market opportunity we are seeing for our NETSCOT visibility and defensibility platform. Within this context, we are reiterating our fiscal year 2023 outlook that we shared with you in early August on our first quarter earnings costs. As a reminder, this outlook targets revenue in the range of $895 million to $925 million and non-GAAP EPS in the range of $1.91 to $2.03 for fiscal year 2023. Jeevan will provide additional color on our outlook in her remarks. In summary, we delivered solid results in the second quarter and first half of our fiscal year 2023. We are driving clear progress to our strategic priorities, and we remain excited about our core service assurance and DDoS security solutions, as well as our new and innovative Omni solutions. With our unique and powerful platform, deep industry expertise, and established customer base, we are well positioned to help customers address the challenges and opportunities of today's increasingly connected and complex digital world. We look forward to sharing our progress with everyone throughout the remaining of our fiscal year. With that, I'll turn the call over to Michael. Thank you, Anil.
spk08: Good morning, everyone. Slide 10 outlines the areas that I will be covering today, starting with customer wins. In our service provider customer vertical, we continue to expand our install base by leveraging both our incumbency and rich portfolio of offerings to better support providers as they steadily advanced their 5G build-out. As an example, during the quarter, we received a mid-seven-figure order from a Tier 1 North American carrier that has consistently increased their 5G-related purchasing from us. This order was a combination of additional radio frequency propagation modeling, service assurance for their radio access network, and other 5G-related products to aid in the migration and capacity expansion of their network. Importantly, in addition to leveraging our solutions within their mobile business, this customer is also utilizing our service assurance platform within their corporate IT systems. In our enterprise customer vertical, we received a low eight-figure order from a large North American health insurance organization during the second quarter. Last year, this customer placed a seven-figure order with us for service assurance solutions, and this quarter they added full Omnis cybersecurity suite and additional service assurance solution to further utilize our platform's integrated capabilities. With the convenience of our shared visibility platform and power of our deep packet inspection at scale, we continue to see our comprehensive suite of enterprise solutions garnering attention among our customers. Finally, as Anil mentioned in his discussion of our recent threat intelligence report, We continue to see an increased awareness around DDoS attacks and capacity expansion stemming from the rapid growth in the application traffic and the increasingly tense geopolitical situation around the world. For example, in the second quarter, we received a mid-seven-figure order from a large global financial institution that is based in the U.S. and is also a longstanding customer. to extend the DDoS mitigation capacity and upgrade their key data centers to 100 gigabits capacity. In terms of go-to-market activities, during the quarter, we continued to attend more in-person events, which provided us with additional opportunities to engage with our customers and demonstrate our platform's unique and innovative capabilities. For example, we recently attended the Black Hat Conference, one of the world's leading cybersecurity trade shows, as well as VMware Explore, a conference for digital transformation and cybersecurity. At these high-profile events, we engage with new prospects and existing customers to demonstrate the power of our platform for integrated visibility and cybersecurity. Looking ahead, we plan to attend the upcoming AWS reInvent conference in November of this year, where we will showcase NASCAR's platform as well as our collaboration with AWS. We have also continued to enhance our customer value proposition by collaborating with other major technology companies and have recently announced several of these initiatives. Through these collaborations, we can help our customers to better address the current threat landscape and navigate the challenges and opportunities of our digital world. An example is a joint strategic initiative with Ericsson and Swisscom which was officially announced by Ericsson in October. Through this collaboration, we delivered what is believed to be the world's first solution for cloud-based packet data processing. By leveraging the strength of each organization, this solution can deliver meaningful improvements in network service assurance, analytics, and cybersecurity. For example, this solution combines Ericsson's and NESCAD's technologies to address the challenges of providing end-to-end monitoring and securing 5G networks when in a cloudified and encrypted environment. As a result, Swisscom is utilizing this solution in its newly deployed cloud-native TLS-encrypted 5G network as well as for its existing services to assure the delivery official services with 5G. Going forward, we aim to continue leveraging the strength of our platform to help our customers better navigate and capitalize on emerging opportunities in today's increasingly connected world. Thank you, everyone. That concludes my prepared remarks, and I will now turn the call over to Jean.
spk02: Thank you, Michael, and good morning, everyone. I will review key metrics for our second quarter and first half of fiscal year 2023. and provide some additional commentary on our fiscal year 2023 outlook. As a reminder, this review focuses on our non-GAAP results unless otherwise stated, and all reconciliations within our GAAP results appear in the presentation appendix. Regardless, I will note the nature of such comparisons. Slide number 12 details the results for the second quarter and first half of our fiscal year 2023, focusing on our quarterly performance Total revenue grew 7.6% year-over-year to $228.1 million. Product revenue grew 10% and service revenue grew 5.4%, both on a year-over-year basis. At the end of the quarter, our total backlog was approximately $80 million, consisting of approximately $45 million of fulfillable orders. and approximately $35 million of radio frequency propagation modeling projects, with nearly $20 million of the radio frequency propagation modeling amount categorized as deferred revenue from an accounting perspective. As a reminder, while fulfillable orders are those we believe can be readily converted into revenue upon shipment or fulfillment, the radio frequency propagation modeling projects require certain execution steps in conjunction with the carrier's timing before they can convert to revenue. Gross profit margin was 76.8% in the second quarter, down 1.5 percentage points year-over-year. This quarter's gross margin was impacted by approximately $15 million of radio frequency propagation modeling projects, which had an average gross margin of less than 30%. Quarterly operating expenses increased 2.2% year-over-year, mostly due to the return of pre-pandemic activities, such as in-person events and travel, and partially due to a competitive employment market. We reported an operating profit margin of 23.7%, compared with 22.3% in the same quarter last year. Diluted earnings per share was 57 cents, Clarifying earlier statements, I'll repeat, the diluted earnings per share was 57 cents, compared with 47 cents in the same quarter last year, representing an increase of 21.3% year-over-year. Turning to slide 13, I'd now like to review key revenue trends by customer verticals and product lines. Please note that all comparisons here are on a year-over-year basis, consistent with our other remarks. For the first six months of fiscal year 2023, our service provider customer vertical revenue grew 11%, while our enterprise customer vertical revenue grew 6.4%. During the same period, our enterprise customer vertical accounted for approximately 51% of our total revenue, while our service provider customer vertical accounted for the remaining 49%. Now, turning to our product lines, for the first half of fiscal year 2023, our cybersecurity revenue increased by 14.3%, while our service assurance revenue increased by 6.6%. During the same period, our service assurance product line accounted for approximately 73% of our total revenue, while our cybersecurity product line accounted for the remaining 27%. Turning to slide 14, which shows our geographic revenue mix, in the first half of fiscal year 2023, Our revenue was more concentrated than usual in the U.S., primarily due to higher revenue related to radio frequency propagation modeling projects from Tier 1 domestic carriers. Additionally, one customer represented 10% or more of our total revenue in the second quarter and the first half of our fiscal year 2023. Slide 15 details our balance sheet highlights and free cash flow. We ended the second quarter with $367.1 million in cash, cash equivalents, and marketable securities, representing a decrease of $7.5 million since the end of the fiscal, sorry, since the end of the first quarter of fiscal year 2023. Free cash flow for the quarter was $7.1 million. As a reminder, with regard to share repurchase program activity, We entered into an accelerated share repurchase agreement in our first quarter of fiscal year 2023 to repurchase $150 million of our common stock. We received approximately 70% of the total shares estimated to be repurchased pursuant to the ASR agreement in our first quarter, or approximately 3.3 million shares. We anticipate receiving the remaining approximately 30% of the program shares when the program concludes no later than December 31, 2022. From a debt perspective, we entered the second quarter of fiscal year 2023 with $200 million outstanding on our $800 million revolving credit facility, which expires in July 2026. To briefly recap our other balance sheet highlights, accounts receivable net was $139.1 million, representing a decrease of $9.1 million since March 31st, 2022. The DSO metric at the end of the second quarter of fiscal year 2023 was 52 days versus 64 days at the end of the second quarter of the prior year and 64 days at the end of our fiscal year 2022. Let's move to slide 16 for commentary on our outlook. I will focus my review on our non-GAAP targets for fiscal year 2023. We are reiterating our non-GAAP outlook for fiscal year 2023 that was last presented during our first quarter fiscal year 2023 earnings call on August 4, 2022. As a reminder, for fiscal year 2023, we anticipate revenue in the range of $895 to $925 million, which implies a mid to high single-digit top-line growth rate. The effective tax rate is anticipated to be in the range of 20 to 22%. Assuming between 73 and 74 million weighted average diluted shares outstanding, which includes the estimated impact of the $150 million accelerated share repurchase program, with a partial offset for stock compensation dilution, we expect non-GAAP diluted earnings per share to be between $1 and 97 cents and $2.03. To reiterate and clarify from previous comments, it's $1.97 and $2.03 for the earnings per share guidance. I'd also like to offer some color on the second half of our fiscal year 2023. Assuming the midpoint of our revenue outlook range, we currently anticipate that our remaining fiscal year 2023 revenue will be nearly evenly split between our third and fourth quarters. with expectations for our third quarter revenue to be one to two percentage points higher than our fourth quarter revenue in the skew between third quarter and fourth quarter. With regards to the second half earnings per share, assuming the midpoint of our non-GAAP EPS range, we currently anticipate receiving approximately 60% in the third quarter and approximately 40% in the fourth quarter. As we have discussed previously, our third quarter gross margin will contain a higher product mix of radio frequency propagation modeling project activities, which has a lower gross margin. That concludes my formal review of our financial results. Before we transition to Q&A, I'd like to quickly note that our upcoming IR conference participation is listed on slide 17. Thank you, and I'll now turn the call over to the operator for Q&A.
spk03: At this time, if you would like to ask a question, please press the star and one on your telephone keypad. If you wish to remove yourself from the queue, please 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 from Matt Hedberg with RBC. Your line is now open.
spk05: For Matt Hedberg, thanks for taking our questions. Nice consistency in the quarter here. You're reiterating guidance for the year, which is nice to see. Jean, thanks for the added color on expectations for the second half just there with a lot going on. Maybe could you talk to some of your confidence points for the second half?
spk02: Sure. I think as we mentioned in our earlier comments that we've been seeing good activity across a wide variety of the trends that we participate in, you know, the trends being 5G. So we have some 5G projects that have come in from Tier 1s. We have still calibration that we are executing on, which is in part of the backlog. In the enterprise, we have been seeing digital transformation and some customers going through what I would call a, not necessarily a refresh, but maybe a reconsideration phase of things they had purchased in the past that didn't work out as well in this much more complicated digital environment. And then finally... Within security, as mentioned, we have been updating the roadmap and coming out with the new products that Anil talked about, as well as the initiation of the Omnis. So we have a combined portfolio of solutions now that works well for 5G, digital transformation, the threats of cybersecurity. As you'll note, the backlog in the shippable portion, and that, again, is the portion that was not available It was not able to be shipped at the end of the quarter, but probably has already been shipped and will convert into revenue. We're still consistent with the prior quarters entering backlog. The only thing that changed was the execution of calibration. So when we look forward to the end of this year, you know, at this point we are comfortable with reaffirming our revenue ranges.
spk05: That's great. And then, you know, could you talk to federal business in the quarter with the fiscal year end I think you've previously commented to most of those projects being funded. Just anything around federal worth pointing out for us?
spk01: I think as Gene is looking at this, Matt, it was better than last year, but that's because last year was not that great. So, I mean, there is still uncertainty in terms of the project budgets and timing and the fiscal year was just over. But since it's not a big portion of our total revenue, I think this is probably not the other factors which could impact things in the future than the federal business.
spk02: Yeah, just to add some numerics to that, I would say basically the service revenue in the U.S. federal government, so the portion that is support, has been consistent on a year-over-year basis, which is good, which means that they're still using our products and they still want to use still want to have support on those. Product revenue was probably slightly flat with what it was in Q2. So overall, on a dollar basis, it was relatively consistent with prior year's Q2. That's the U.S. federal government piece.
spk03: We will take our next question from James Fish with Piper Sandler. Your line is now open.
spk07: Hey, guys. I want to follow up on the question before that, before the Fed. With the reiterated guide, I just want to understand the puts and takes you're thinking about here, given the macro environment, especially on the international side where budgets are a little bit tighter, you have elongating sales cycles. Obviously, you guys benefit from the 5G builds. But we did hear from some of your networking peers that have cited weakness here already, just trying to understand how you guys are thinking about you know, order growth in the back half of the year.
spk01: So Jim, thanks for the question. So I think there's another dynamic plays out on our business in addition to the very good backlog we had entering this year. When we look at the networking peers, they are mostly infrastructure companies and we have a trailing effect on both spending cuts and spending opportunities. Once the network built out is done, then you use tools. So I think if we see some headwinds on the macroeconomic side, we'll probably see that and we'll update that at the end of the fiscal year. So we feel comfortable with the range which we have allows us to manage this and with all the other pipeline and other information and visibility we have. And despite some of the things you are saying
spk07: and international side we at this point feel comfortable with the guidance that's that's helpful anil um obviously still elevated backlog i'll agree but um how are you guys thinking about that backlog uh returning to kind of normal as supply chain does start to open up is it is it by fiscal year end of 24 earlier or later and then gene It sounds like there was a little bit more professional services mixed this quarter in the service revenue. Is that right, or is it just kind of a natural flow-through of maintenance starting to pick up as product grew last year?
spk02: What is flowing through this quarter in service revenue is something that happens almost every year. We have back maintenance people that sign up for contracts. after their original due date. And so any period of service that you've provided flows right through revenue at that time. So I think in Q3 of last year, we had a lot of back maintenance or some back maintenance. Q2 of this year, I would say the delta in back maintenance was probably maybe attributed to about $5 million. Okay.
spk07: And then on the backlog timing, like when we Go back to the, I think the historical range was, you know, about 25, 30 million historically. We're at around 80 today, I guess. Are you guys thinking about it as like a six quarter or eight quarter kind of timeframe?
spk01: Well, I think overall it will be somewhere in between because of, uh, uh, hopefully higher growth because of our cybersecurity initiatives. So some of the new initiatives, even though this year we feel comfortable with the guidance. A lot of the new things have not really significantly contributed to this, and we have a general feeling that cybersecurity is less prone to macro economic challenges than service assurance. So the investment we made last year, so our plan is that our backlog will be somewhere in between the traditional one, which we had, like you talked about, $30, $40 million, to The elevated one mainly because of calibration. I mean, calibration business is still possible this year, but it will not be at the size of what it was last year. So it's hard to predict what the backlog is going to be like this or lower or higher in the next 18 months. But I think when we talk about the guidance for next year, it will reflect our insights into that.
spk07: Helpful, guys. Thank you.
spk03: Thank you. We will take our next question from Kevin Liu with K. Liu and Company. Your line is now open.
spk06: Hi. Good morning. Just wanted to clarify some comments around kind of the macroeconomic impact on your business. Have you guys seen anything to date, you know, in terms of delays or project cancellations that are concerning at all? And then just wondering, you know, with cybersecurity maybe being a little bit more insulated, whether you're expecting your service provider business to hold up fairly well.
spk01: Overall, I think we see, Kevin, that so far at least we have not seen any delays, which has got to my attention, any big deals or anything. And how this changes over the next three, four months, we'll see. But we are still benefiting here and there from the – we have – very little supply chain problem because being a software company and the way we package our software and we have some partners, we take care of that. So we think that we might, even in this environment, we might benefit from some supply chain dollars coming from other vendors to us in this last quarter. So right now, I think we are not seeing those effects. But like I said earlier that We'll have to carefully watch it, and when we provide the guidance for next fiscal year, we will keep that into account. But so far, luckily, we are not seeing any real issues. We keep hearing in other earning calls, but fortunately, we are not seeing anything so far.
spk06: I understand that's good to hear. And then just on the expense side of things, you guys talked about, you know, things starting to return to kind of pre-pandemic types of spend with in-person activities. Just wondering, as we look out to next year and maybe in the future, do you feel like this is kind of a more normalized baseline that should recur from year to year, or do you think there's even more kind of in-person activities that'll continue to pick up and that we should account for?
spk02: I would say that the amount of travel is not as high as we would have originally thought in this fiscal year. So next year, I could see where some travel would repopulate in the P&L. Also, depending on economic times and as a lot of people have experienced significant compensation rate increases, we would have to see if that occurs in our next fiscal year also. Barring that, those two off the top of my head, I don't see any other operating expenses that would come through. And so as the company generates incremental revenue, we will continue to have traditionally strong flow through to our operating margin and our earnings per share.
spk06: All right, great. Congrats on the quarter and thank you for taking the question.
spk03: Thank you. We have no further questions on the line at this time. I will turn the program back over to Tony Piazza for any additional or closing remarks.
spk00: Thank you, operator. That concludes our call for today. Thank you for joining us and have a good day.
spk03: This does conclude today's program. Thank you for your participation. You may disconnect at any time.
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