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Netscout Systems Inc (NASDAQ:NTCT)
Q2 2021 Earnings Call
Oct 29, 2020, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Please standby your program is about to begin. Ladies and gentlemen, thank you for standing by and welcome to Net Scout'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 Peot, our Vice President of Corporate Finance and his colleagues at Net Scout are on the line with us today. If you require operator assistance at any time, please press zero. I would now like to turn the call over to Tony Peot to begin the Company's prepared remarks.

Tony Peot -- Vice President of Corporate Finance

Thank you, operator and good morning everyone. Welcome to Net Scout's Second Quarter of Fiscal Year 2021 Conference Call for the period ended September 30, 2020. Joining me today are Anil Singhal Net Scout's President and Chief Executive Officer, Michael Szabados, Net Scout's Chief Operating Officer and Jean Bua Net Scout's Executive Vice President and Chief Financial Officer.

There is a slide presentation that accompanies our prepared remarks, you can advance the slide s 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. Moving on to slide number three. Today's conference call will include forward-looking statements. These statements may be preface by words such as anticipate, believe and expect and we'll 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. Net Scout 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 involve 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?

Anil K. Singhal -- Co-Founder, President & Chief Executive Officer ,Chairman of the Board

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 $25.3 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 US federal government sector which impacted enterprise revenue. The quarter benefited from our focus on cost control as well as by pandemic related travel restriction.

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 security initiated in the year with even greater as a result of the pandemic and the new normal of operating with remote resources and interacting with the customers in a more virtual fashion as they look to address speed agility and cost. On the security front that landscape continues to rise rapidly and the pandemic has created more opportunities for bad this to disrupt organization given that distributed operations.

Last month we issued our first half 2020 third intelligence report which highlighted how cyber criminals are exploiting the pandemic to a radical change in deed of method they are using. The report discuss how cyber criminals launch record breaking tags on online platforms and other services during the pandemic and increasingly going to connect network these attacks targeted e-commerce, education platform, financials services and healthcare services.

There multi back to back attacks were shorter, faster hard hitting and more complex. These new methods put pressure on security being 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 leaders detection and mitigation solution like ours. This dynamic has certainly played on and important part in the strong performance of our security solution in the quarter and year-to-date. Michael will highlight some of it and managed related to this at times during his remarks. Now let's move to slide number eight to rereview our 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 tested brand, strong customer relationship dedicated team and solid financial profile. That said, we are not immune from the impact of Covid19 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. This dynamic has caused a long purchase cycles make the timing magnitude and funding for these difficult to predict, which we anticipate will negatively impact our traditionally stronger second half of the fiscal year financial results.

As a result we now expect that 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 inline with our fiscal year 2020 non-GAAP earnings per share as we continue to prudently manage 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 execute our strategy and deliver stable results in this tough and uncharted COVID 19 environment. We appreciate the continued dedication and support of our employees as we navigate the global pandemic the long-term market trends in the flavors such as digital transformation cloud migration increased and other stakeholders as we navigate the global pandemic. With long term market trans in our favor such as the digital transformation, cloud migration increased cyber tracks and 5G networks next started well position 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 for his remarks.

Michael Szabados -- Chief Operating Officer

Thank you, Anil. And good morning everyone. slide 10 outlines the areas I will cover, first, it cost a little bit.

Starting with customer events 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 forward a major European carrier, a long-standing oil cost that provided mid seven figures of revenue in the quarter.

The investment enables the carrier to expand their 4G capacity and positions then to transition to 5G solutions in the future. On the 5G front we will allow to make seven figure a user trial with a Tier one North American carrier as they start to explore a stand-alone, so-called 5G network.

It is still early days for North American stand-alone 5G visibility project 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 Assurant Solutions has 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 global and deal we won, was it 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 patient management system, the scale and completeness of our solution as well as the expertise of our team.

One of the deal over multiple competitors with partial solutions. On the Internet. another new logo and competitive win was our low seven figure deal with a major stock exchange that neither the faster and more reliable solution to triage into abortion application problems. They selected our service assurance solution because of our rich data source and strong analytical capabilities we solve their challenges as we replaced the major competitor solution that was falling short of their expectation.

Both of these cases the security of new customers and the result of our reputation as a trusted leader is service excellence, we innovative and reliable solutions, but we have also identified opportunities extend these relationships in these deals as we leverage our cross-selling capabilities to our integrated sales team. On the security front the transport service provider and enterprise verticals. We continue to explain a strong interest in our DDoS protection, especially as the sophistication and volume of FX 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 US customers, prompting even more attention on this space and other solutions checked this level of protection requires on premise deployment, such as our Board HD-- solution both for rapid multinational and and sophisticated layer seven protection to demand for our ATV solutions have increased due to large customers redesigning their infrastructure now settling in for remote work for the long haul after the initial rush to shore up the fences and the pandemic started.

This trend is exemplified in a mid six with the deal with the large insurance company domestically and the low seven figure deal with a leading international stock exchange. We are excited about our ability to provide these solutions to our customers who are unified worldwide sales force.

In terms of go-to-market activities, we continue to build our vendor strategically critical partner to leading, virtualization and cloud providers. In October we participated in the annual VMworld event at Technology alliance partner, there were more than 150,000 participants that joined virtual event over the 10-day duration. We presented and showcase our applications performance with performance management and troubleshooting capabilities in VMware virtualized on-prem and AWS cloud deployments.

Also recently our AWS migration ISV partner competency has been approved by AWS meaning that AWS certifies the customers, the NetScout has been invested validated and verified against the high bar and the AWS will promote NetScout through the AWS sponsorship program. On the security front, during the quarter on deal a global research leader in technology ranked NetScout our Board as the top and largest vendor in the DDoS market highlighting our new security investments and on visibility and that analytics.

Finally as a leader in our industry as only discussed in September we published our semiannual threat intelligence report. The report was picked up by approximately 50 publications and translated into five languages as our threat intelligence report is considered an industry about annual report. That concludes my prevailing marks and I will now turn the call over to Jean.

Jean A. Bua -- Chief Financial Officer

Thank you Michael and good morning everyone. I really feel key second quarter and first half of fiscal year 2021 metrics and 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 declined by 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 quarter.

Our second quarter of fiscal year 2021 gross profit margin was 74.7%, down 1.9% points over the same quarter last year due to product mix, most notably increased radio frequency propagation modeling project revenue 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% for the prior year, primarily due to continued cost control and pandemic related travel restriction. We reported an operating profit margin of 19.4% compared with 14.6% in the same quarter last year. Diluted earnings per share was $0.38 compared with $0.28 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 revenues for the first six months of the fiscal year. Turning to slide 14, which shows our geographic revenue mix on GAAP basis, revenue budget. The gain was 58% in the United States and 42% internationally. There were no customers in the quarter of 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 this 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 gross leverage covenant providing potential borrowing capacity if needed. Our revolving credit facility expires in January 2023 and it has no required principal repayments of the 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, at 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 the nil 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, inline with our fiscal year 2020 earnings per share number as we continue to prudently manage our cost structure. But 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 inline 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 diluted share outstanding for the year to be approximately 74 million share. 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. I'll now turn the call over to the operator for Q&A.

Questions and Answers:

Operator

[Operator Instructions] We'll take our first question today from Kevin Liu with K. Liu & Company. Your line is open.

Kevin Liu -- K. Liu & Company -- Analyst

Hi, good morning. First question here. 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, 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?

Anil K. Singhal -- Co-Founder, President & Chief Executive Officer ,Chairman of the Board

Thanks for the question, Kevin. So I think there are two areas, one is certain industries where there is unpredictable timing of whether there was 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 is buyback the number one.

The second one is elongated sales cycle and those are in two buckets, one is we released 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 extend the sales cycle.

And second thing is people who are new logos. Even though we had some successes, there are a lot of interest in our new software-based offerings, especially in the enterprise. But new logos for 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 are COVID-related and which we certainly counting on this year, which has changed.

Kevin Liu -- K. Liu & Company -- Analyst

Got it. And then just quickly in the past, you've talked about enterprise kind of emerging as an interesting opportunity for 5G. Are you still seeing that trend build-out? Maybe you can talk about in terms of how large of an opportunity you see that over the coming years?

Anil K. Singhal -- Co-Founder, President & Chief Executive Officer ,Chairman of the Board

Yeah. I see that as a follow on opportunities. So if you had been 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 caveat using our 5G solution for user monitoring. And we are in the early phases of that. And much later than that will be carry participating in private 5G because the cloud vendors and the carriers will have to leave those efforts also. So I see that as a more private 5G and more of a longer-term opportunity. And then the carrier 5G.

Kevin Liu -- K. Liu & Company -- Analyst

Got it. That's helpful, thank you for taking the question.

Anil K. Singhal -- Co-Founder, President & Chief Executive Officer ,Chairman of the Board

Sure.

Operator

Our next question comes from James Fish with Piper Sandler. Your line is open.

James Fish -- Piper Sandler -- Analyst

Hey, guys. Glad to hear that you're all doing well. On the security side, you said 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 harbor?

Anil K. Singhal -- Co-Founder, President & Chief Executive Officer ,Chairman of the Board

I think they have -- I mean, they will need, but I don't -- I think they have quite -- I mean, 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 next part being much bigger enterprise business versus harbor. We have seen a lot of opportunity in that area with the product called AED and which basically looks at application layer type, which is a new set of attack vectors. It's the on-prime device or in the entry to the cloud and then it gets into trouble it fix signals to harbor cloud.

So that's a big area of growth we are counting on and we have released couple of solutions. And it started the go-to-market initiative, which has been sort of slowed down because our people are not being able to do speedy trials. So while there will be, we see some steady-state business on the carrier side and the growth area for securities is DDoS for the enterprise with application-layer attack forecast Layer seven attack and a new product we have 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 provider, both for 4G and 5G. And those are the things -- so those are somewhat different than the past harbor revenue growth area more capacity in the carriage.

James Fish -- Piper Sandler -- Analyst

Yeah. Got it. And then Jean, for you. Can you give us some color between within harbor across enterprise and carrier like you typically do and also billings appeared fairly strong? Was there a good amount of product backlog that should give us some confidence here that our trends are or it could be a little bit better than you're expecting or were you just seeing greater attach of additional services?

Jean A. Bua -- Chief Financial Officer

So all of our -- I guess we -- If we can talk about the year-to-date harbor generally and service provider a good Second quarter and probably is flat on a year-over-year basis. An enterprise for the year to date, they grew very strongly. They grew about a 30% increase. And that's mostly in the areas where they again play too very large institutions like financial institutions for the government. They continue to do well in harbor given the details of the security in nature. They are also doing much better because of the integration of the sales force that has many more opportunities now with the service assurance in any of the issues that they had more than a year ago with understanding their territories are behind them. So, harbor has done pretty well for the first half of this year.

James Fish -- Piper Sandler -- Analyst

And then on the billings being stronger. I mean is it more product backlog than normal or was it greater cash of additional services this quarter?

Jean A. Bua -- Chief Financial Officer

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 OK growth rate for the year-to-date on them.

James Fish -- Piper Sandler -- Analyst

Got it. Thank you.

Jean A. Bua -- Chief Financial Officer

You are welcome.

Operator

Again, that is star and one for your questions today. We'll go now to Eric Martinuzzi with Lake Street. Your line is open.

Eric Martinuzzi -- Analyst

Just a clarification on the full-year revenue guide. I want to make to try and put some numbers around the mid to upper single digits. Is this down prior to 8%, down 4.9%. Do you have a preference between those two?

Jean A. Bua -- Chief Financial Officer

I guess I would say we think mid 4% to 6%. And then the upper single digits is 7% to 9%. So, my range would be 4% to 9%.

Eric Martinuzzi -- Analyst

Okay. All right. And then on the Fed, historically, the September quarter would be a good quarter for NetScout with the federal business. Are we looking at something that's just a vagary of being a sub to the main, where it's just lumpy, or is this potentially kill projects? Is it pending new appropriations? Could you snap back in December? Are we looking at a multi-quarter issue in your view?

Michael Szabados -- Chief Operating Officer

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 are the selected partner but something radically changing in the fiscal year, I think, is unlikely.

Eric Martinuzzi -- Analyst

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 got to believe part of that is just less TV, less conferences because of COVID. but we're -- what are our cost structure points of leverage as you are trying to manage to that non-GAAP EPS target?

Jean A. Bua -- Chief Financial Officer

So for the first one would obviously be the condition of the pandemic and the amount of travel that the sales once will do. In Q3, I don't view them doing incrementally more travel than they did in Q2. The upper levels that we have for the rest of the year, generally, our headcount, the backfilling of any attrition, or if there are certain investment areas that we'd like to make in sales, whether we continue with that investment or delay that investment.

And they are 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 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.

Eric Martinuzzi -- Analyst

And last question for me. It comes down to the services revenue. Historically, we would see an uptick here, but this is -- 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? Is that up sequentially or is your expectation that it could in fact be down sequentially?

Jean A. Bua -- Chief Financial Officer

I would say service revenue is fairly based in -- which is why we're generally very accurate on that forecasting service revenue. I wouldn't say when I look at our model, I mean, just one thing for. I'm looking at the mid point. I would say service revenue looks like it's going to be relatively consistent with the service revenue that we achieved in FY 2020. As you point out, Q2 of this year compared to last year was actually pretty flat. Last year, you 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 at estimates that service revenue will be generally flat to last year's level.

Eric Martinuzzi -- Analyst

That's helpful. Thanks for taking my questions.

Jean A. Bua -- Chief Financial Officer

Thanks, Eric.

Operator

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.

Anil K. Singhal -- Co-Founder, President & Chief Executive Officer ,Chairman of the Board

That concludes our call for today. We appreciate everybody joining us and have a great day.

Operator

[Operator Closing Remarks]

Duration: 36 minutes

Call participants:

Tony Peot -- Vice President of Corporate Finance

Anil K. Singhal -- Co-Founder, President & Chief Executive Officer ,Chairman of the Board

Michael Szabados -- Chief Operating Officer

Jean A. Bua -- Chief Financial Officer

Eric Martinuzzi -- Analyst

Kevin Liu -- K. Liu & Company -- Analyst

James Fish -- Piper Sandler -- Analyst

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