NetScout Systems, Inc. (NTCT) Q2 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to NetScout’s Second Quarter of Fiscal Year 2013 Operating Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. With us today is NetScout’s President and CEO, Mr. Anil Singhal. He is accompanied by NetScout’s Chief Operating Officer, Mr. Michael Szabados; and NetScout’s Chief Financial Officer, Ms. Jean Bua. At this time, I will turn the call over to Ms. Cathy Taylor, NetScout’s Director of Investor Relations, to provide the opening remarks. Ms. Taylor, please proceed.

Thank you, and good morning, everyone. Welcome to NetScout’s fiscal 2013 second quarter conference call for the period ended September 30. Before we begin, let me remind you that during the course of this conference call, we will be providing you with a discussion of the factors that we currently anticipate may influence our results going forward. These statements include forward-looking statements made pursuant to the Safe Harbor provisions of Section 21E of the Securities Exchange Act of 1934 and other federal securities laws. These forward-looking statements may involve judgment and individual judgments may vary. Forward-looking statements include expressed or implied statements regarding future economic and market conditions, guidance for fiscal year 2013, acquisition integration success and new product releases. It should be clearly understood that the projections on which we base our guidance and other forward-looking statements and our perception of the factors influencing those projections are highly likely to change over time. Although those projections and the factors influencing them will likely change, we will not necessarily inform you when they do. Our company policy is to provide guidance only at certain points in the year such as during the quarterly earnings call. We do not plan to update that guidance otherwise. Actual results may differ materially from what we say today and no one should assume later in the quarter that the comments we make today are still valid. For the further discussion of the risks and uncertainties that could cause our actual results to differ, see the specific risks and uncertainties discussed in NetScout’s Annual Report on Form 10-K for the year ended March 31, 2012 on file with the Securities and Exchange Commission. Our quarterly financial results are included with our earnings press release. We report our results on a GAAP basis as well as on a non-GAAP basis. Our non-GAAP results eliminate the GAAP effects of our acquisitions by adding back revenue related to deferred revenue revaluation and removing expenses related to the amortization of acquired intangible assets, the GAAP effects of stock-based compensation and restructuring charges. Our non-GAAP results also exclude certain expenses relating to our acquisitions including compensation for post-combination services and business development charges. We exclude the related impact of all these adjustments on the provision for income taxes. The difference between GAAP and non-GAAP are disclosed in reconciliation tables in the press release. We believe these adjusted financial measures will enhance your overall understanding of our current financial performance and our prospects for the future. We use these adjusted financial measures internally for the purpose of analyzing, managing and forecasting our business. We have included on today’s webcast a slide presentation that provides a summary of key financial data that accompanies the financial section of today’s discussion. For those listeners who have dialed into the call this morning and would like to view this presentation, you can find it by going to our website at www.netscout.com/investors and then clicking on today’s webcast. I will now turn the call over to Anil Singhal, our Chief Executive Officer.

Thank you, Cathy. We are very pleased to report solid results for the second quarter of fiscal year 2013. Our non-GAAP revenue grew 17% to $84.7 million while our non-GAAP earnings per share grew 42% to $0.34 this quarter, compared to the same period of the last fiscal year. Jean will discuss our second-quarter comparison in more detail later in the call. More importantly, looking at the results of the first half of the fiscal year 2013, we are very well-positioned to deliver on the full-year guidance we provided at the beginning of the fiscal year. First-half non-GAAP revenue was $161.2 million, an increase of 19% from the last fiscal year. Our first-half non-GAAP earnings per share was $0.33, which is a 43% increase from the prior year. In addition, we are entering the third quarter with one of our highest backlogs ever historically of over $90 million. During the first half, the new business bookings component, which is the leading indicator of our business growth, was up 15%. New business bookings from service providers remain strong, and we continue to win significant new projects as wireless carriers adopt our market-leading IP solutions. We are on track with the integration of the technology that we acquired from Accanto Systems in July. Accanto’s voice service assurance product are synergistic with our packet-flow strategy and bring important voice service monitoring for both legacy voice environment and next-generation network voice services. With this technology, we’ll be able to offer both existing and new customers a robust set of legacy and next-generation voice service management capabilities in a single vendor solution giving us an increasingly strong position to compete for business in Tier 2 wireless carriers worldwide, where demand for a single vendor solution is high. Our strategy remains focused on extending our technology leadership in IP-based packet-switched environments to monitor and capture all traffic traversing a single link using a single probe and provide the lowest total cost of ownership to our customers. We will share our product integration blueprints and go-to-market strategy later this year. Further, in the service provider space, we signified our growing focus on the Cable MSO vertical with our inaugural participation in the SCTE Cable-Tec Expo 2012 this week where we announced our solution to address the service delivery management needs of cable MSOs globally. NetScout provides MSOs, which is multiple system operators, with real-time, end-to-end visibility into the IP infrastructure that facilitates the delivery of next-generation business and consumer services. We are building on our already strong momentum in the mobile operator segment, and NetScout has also achieved deployment with 5 top tier MSOs in North America, Europe and Asia. I’m also pleased to note that, based on our research, we believe that our continued success has earned us the leading market share in the IP-based segment of the service provider market. Many of our customers are experiencing challenging global economic conditions. Despite these conditions in our financial and general enterprise verticals, we have seen new business growth of 4% in Financial Services and 2% in the General Enterprise sector for the first half of fiscal 2013. Selected domestic-based customer are performing hardware upgrade, extending coverage of their existing infrastructure, as well as adopting our technology for unified service delivery. We expect that the global economic condition will remain the same for the foreseeable future. Our government customers are also facing the uncertainty of the upcoming fiscal year spending. Our customers have engaged in long-term strategic projects that require multiple funding steps along their timeline. While our pipeline for the government showed demand from a customer base, the ultimate funding did not happen. On a first-half basis, our government vertical’s new business bookings declined 32%. We continue to invest in extending the reach of our solutions within the enterprise to address the new challenges presented by cloud-based services and the proliferation of bring-your-own device, or BYOD, mobile devices expected to deliver enterprise-class services. NetScout Unified Service Delivery Management solutions address the needs of the emerging new environment and provide service assurance and performance management solutions at scale across the entire enterprise. In summary, we are continuing to enhance our nGenius Service Assurance Solution to serve the needs of our global customer base. Based on our first-half results, we are reaffirming our non-GAAP revenue guidance range of $340 million to $355 million and are raising the lower end of our GAAP and non-GAAP EPS guidance by $0.03. The revised GAAP EPS range is $0.94 to $1.00 and the non-GAAP EPS range is now $1.24 to $1.30. With that, I’ll turn the call over to Michael.

Thank you, Anil. In my comments, I will focus on our execution and operational performance this past quarter. From a product development perspective, we are continuing to enhance our nGenius Service Assurance Solution to serve the needs of our customers. During the quarter, we released an important set of enhancements and upgrades to our nGenius suite of products in support of our Unified Service Delivery Management, or USDM, strategy. Key deliverables included continued enhancement of our service provider, service assurance offering in support of operations in wireless carrier LTE networks. We also delivered to our enterprise customers additional integration of our nGenius voice and video functionality across the nGenius product suite as well as integrating our Packet Flow Switch product line into nGenius performance manager. We also delivered additional ESI data sets supporting both service providers and enterprise customers. While our federal business has been impacted by spending concerns, we continue to invest in our ability to service our federal government customers and have successfully differentiated our solutions to extend this certification and accreditation work. Most recently, our nGenius Service Assurance Solution has been certified by the Defense Information Systems Agency, or DISA, for the Department of Defense Unified Capabilities Approved Products List and approved by the National Information Assurance Partner as Common Criteria certified at Evaluation Assurance Level 3, EAL 3. These certifications validate that the nGenius Service Assurance Solution meets the rigorous testing and technical requirements for interoperability and security mandated by the DoD, National Institute of Standards and Technology and National Security Agency. In the Enterprise segment, we are continuing our strategy of Unified Service Delivery Management in that consolidating multiple IT operations capabilities and on the common Packet Flow platform. We are gaining increasing traction with our new Packet Flow Switch and Unified Communication Solution sets. These offerings are both increasing the value of our installed instrumentation and giving us access to new budgets. With these offerings and the increased capabilities being developed in USDM, NetScout will continue to increase its portfolio of products for our enterprise customers to further expand our longstanding leadership position. Let me highlight 2 specific examples that illustrate our strategy that has produced results for top-tier enterprise customers in our fiscal second quarter. One of our large banking customers in consolidating and upgrading their data centers to better support their new IT services such as mobile banking have continued to depend on NetScout as their service assurance platform. This past quarter, they placed a large order in excess of $1 million to expand their NetScout instrumentation. Another example is a deal over $1 million from a Fortune 100 manufacturing company. Our success with this customer was spearheaded by their need for service assurance of their initial deployment of Microsoft Lync collaboration tools where our unified communications solution was the right answer. In the course of planning the deployment for our UC solution, we were able to identify and bring additional service assurance business from other IT operations teams inside the company validating our USDM value proposition. We have achieved some new milestones in our continued investment in sales productivity and effectiveness as well. This past quarter, we completed the development and successful deployment of our new CRM solution. We also trained our worldwide sales force in consistent selling methodology and solution positioning to accelerate success with our global customer base. In sharpening our focus on our 2 markets, we continue to grow our service provider and enterprise expertise centers that drive shared learnings, knowledge transfer and provide overlay sales support to increase our rate of success in many top-growth opportunities. Further, we have completed the alignment of EMEA sales with these 2 segments, Service Provider and Enterprise segments, while also leveraging the new sales talent from the Accanto acquisition. Finally, during the quarter, we won a number of awards and here are some of the more notable ones that I’d like to share with you. NetScout received the 2011 Product of the Year Award for nGenius Service Assurance Solution from TMC and Crossfire Media, the sponsors of Mobility Tech Zone. We were awarded for delivering one of the most innovative products of 2011 and for leadership in the mobile broadband industry. We also received the Communications Solutions Product of The Year from TMC. NetScout was honored for vision in excellence in advancing voice data and video communication solutions and leadership in the communications industry. I would now like to turn the call over to Jean for the financial discussion.

Thank you, Michael, and good morning, everyone. As Cathy said earlier, we have a slide presentation to accompany this section of the call. You may feel free to follow along with the slides as I speak. However, I will discuss our results without needing to reference the slides. We will be starting with the third slide which shows our second quarter income statement. As Anil outlined, our business produced solid results for the second quarter of fiscal year 2013. Our non-GAAP revenue grew 17% while our non-GAAP earnings per share grew 42%. Our second quarter non-GAAP total revenue was $84.7 million, which is an increase of 17% from the same quarter in fiscal year 2012. Within non-GAAP total revenue, non-GAAP product revenue was $46.2 million which is an increase of 21% over the same quarter in fiscal year 2012. Service revenue was $38.5 million on a non-GAAP basis, which is an 11% increase from the same quarter in the prior year. The GAAP total revenue for the same period was $84.5 million which is an increase of 16% from the same quarter in fiscal year 2012. Within GAAP total revenue, GAAP product revenue was $46.2 million which is an increase of 21% over the same quarter prior year. Service revenue was $38.4 million on a GAAP basis which is an 11% increase from the same quarter in the prior year. On a non-GAAP basis, our earnings per share for the second quarter were $0.34. This is $0.10 higher than the second quarter of fiscal year 2012 and represents a 42% increase. On a GAAP basis, our earnings per share were $0.23. This is $0.06 higher than the second quarter of fiscal year 2012 and represents a 35% increase. Turning to Slide 4, the business maintained strong gross profit margins and growing operating margins. On a non-GAAP basis, our gross profit was $69.4 million representing an 81.9% margin. This margin is 1.7 percentage points higher than the same quarter from the prior year. Our GAAP gross profit for the quarter was $67.6 million and GAAP gross margin was 80%. Non-GAAP income from operations was $23.8 million. Our non-GAAP operating margin for the quarter was 28% which is a 5.4 percentage point increase from the same quarter of prior year driven by the 17% revenue growth. GAAP income from operations was $16.9 million. GAAP operating margin was 20% which is a 4.2 percentage point improvement over the same quarter in the previous year. Non-GAAP net income was $14.4 million or $0.34 per diluted share. The non-GAAP net income after tax margin was 17.1%, which is up 2.9 percentage points from a year ago. GAAP net income for the quarter was $9.9 million yielding earnings per diluted share of $0.23. GAAP net income after-tax margin was 11.7% which is an increase of 2 percentage points from a year ago. The major differences between our non-GAAP and GAAP income from operations for the quarter is the exclusion of stock-based compensation for $2.5 million and about $3 million of costs associated with our acquisitions which includes amortization of intangibles for $2.1 million, business development expenses totaling $500,000 and $1.2 million for restructuring charges. These are detailed in our reconciliation of our non-GAAP to GAAP results presented in our press release. The quarter’s provision for income taxes is recorded based upon a full year tax rate of 36.3% on a GAAP basis. Our GAAP tax rate for the quarter is 40.9%. Consistent with past practice, we have used the statutory tax rate of 38% to tax effect the non-GAAP adjustment. The adjustments reconciling our non-GAAP results to our GAAP results are summarized in the reconciliation table included with our press release. Turning to Slide 5, which shows our total bookings and new business bookings components, total bookings in Q2 were $86.8 million, a slight decrease of $1.4 million, or 2% year over year. Within total bookings, our new business bookings were $70.2 million, an increase of $2.1 million, or 3% over the prior year’s second quarter. Service contract renewal bookings in the quarter were $16.5 million, a decrease of $3.6 million, or 18% year over year. Product backlog at the end of the quarter was $19.5 million. The components of our new business bookings for the second quarter of fiscal year 2013 were as follows: services providers, 47%, financial enterprise, 24%; government enterprise, 10% and general enterprise, 19%. This compares with the prior year’s quarter’s new business booking components as follows: service providers, 22%; financial 32%, government 25%, general enterprise, 21%. Slide 6 is a summary of our deals for this quarter. For large deals within the quarter, 142 customers gave us orders over $100,000 in comparison to 152 customers from last year. We received 13 orders over $1 million of which 5 came from service providers, 4 from financial services, 2 from government and 2 from general enterprise. This compares to 14 orders over $1 million that we received last year in the second quarter. Last year’s orders that were greater than $1 million included 5 from service providers, 5 from financial services, 2 from government and 2 from general enterprises. For year-to-date fiscal 2013, Slide 7 shows our results. For the first half of fiscal year 2013, non-GAAP revenue was $161.2 million which is an increase of 19% from fiscal year 2012. GAAP revenue for the first half of fiscal year 2013 was $160.9 million which is an increase of 18% from fiscal year 2012. Non-GAAP and GAAP product revenue was $86.4 million for the first half of fiscal year 2013, an increase of 28% over prior-year non-GAAP and GAAP revenue. Non-GAAP service revenue was $74.8 million and GAAP service revenue was $74.5 million for the first half of fiscal year 2013. This is an increase of 9% over prior year for both non-GAAP and GAAP service revenue. On a non-GAAP basis, our year-to-date gross profit was $130.5 million representing an 81% margin. This margin was 90 basis points higher than the first half of prior year. Our GAAP year-to-date gross profit was $127.1 million and GAAP gross margin was 79% which is 70 basis points higher than the first half of the prior year. Non-GAAP year-to-date income from operations was $37 million. Our year-to-date non-GAAP operating margin was 23% which is 4.6 percentage points higher than prior year. GAAP year-to-date income from operations was $25.1 million. GAAP operating margin was 15.6%, 4 percentage points higher than the previous year. On a non-GAAP basis, our year-to-date earnings per share for fiscal year 2013 were $0.53. This is $0.16 higher than year to date for fiscal year 2012 and represents a 43% increase. On a GAAP basis, our year-to-date earnings per share were $0.35. Turning to Side 8, which shows our total bookings and new business bookings growth for the first half of fiscal year 2013, total bookings year to date for fiscal year 2013 was $153.9 million up $12.9 million, or 9% year over year. Within total bookings, new business bookings were $121.5 million, up $15.9 million, or 15% over the prior year. Renewal bookings were $32.4 million, which is a decrease of $3 million, or 8%. In spite of the economic challenges facing our customers across the globe in the first half of fiscal year 2013, all of our business verticals experienced growth in new business bookings over the prior year with the exception of government. We believe the decline in the government new business bookings is due to the budget uncertainty around long-term strategic government projects. Our new business bookings for Service Provider sector grew 70% on a year-over-year basis which was helped by the expansion of LTE deployment by our customers around the globe. Our new business bookings for the Financial Enterprise sector grew modestly at 4% on a year-over-year basis, our General Enterprise sector grew 2%. The new business bookings for government vertical decreased 32% year over year largely due to the federal government deferring spending on long-term strategic initiatives. Our federal government new business bookings decreased 38% while the rest of the government business, which includes foreign governmental agencies and state governmental agencies, decreased 8%. Slide 9 shows our new business bookings by vertical. The components of our new business booking for fiscal year 2013 were as follows: service provider, 41%; financial enterprise, 27%; government enterprise, 11%; general enterprise, 21%. This compares with the prior-year new business bookings components as follows: service provider, 28%; financial enterprise, 30%; government enterprise, 19%; general enterprise, 23%. Turning to Slide 10. This is a depiction of our year-to-date revenue by geography. For the first half of the fiscal year, revenue from international sales was 24% of total revenue as compared with 25% of total revenue for fiscal year 2012. Within our international sales, Europe delivered 11% which was consistent with last year. Our Asia sales percent was 5% compared to 6% last year. Our other international sales were 8%, which was the same as last year. Slide 11 includes highlights from our balance sheet. We continue to maintain strong liquidity. At the end of the quarter, we have invested cash, short-term marketable securities and long-term marketable securities of $235.6 million. This represents an increase of $22.1 million from the prior year-end balance of cash and short and long-term marketable securities of $213.5 million. Our year-to-date free cash flow generation of $51.8 million was $39.7 million higher compared to fiscal year 2012. In this quarter, we repurchased 250,000 shares of treasury stock worth $5.9 million. On a year-to-date basis, we have repurchased 500,000 shares for $10.9 million. Accounts receivable net of allowances was $28.9 million down from $69.8 million at the end of fiscal year 2012. Days sales outstanding were 30 days for the quarter. This is down from 62 days for the second quarter of last year. Inventories were $8.3 million. This is a $300,000 increase from the fourth quarter of fiscal 2012. Inventory turns were 3.2 times for this quarter versus 2.4 times for the second quarter of fiscal year 2012. Additionally, our total deferred revenue was $98 million which is a decrease of $14 million from fiscal year 2012 year end. Turning to our guidance for fiscal year 2013. Slide 12 illustrates our growth for revenue and earnings per share. For fiscal year 2013, we are reiterating the non-GAAP revenue guidance of $340 million to $355 million and raising the low end of guidance for our non-GAAP net income per share to be in the range of $1.24 to $1.30. For fiscal year 2013, we are reiterating our GAAP revenue guidance of $340 million to $355 million and adjusting our GAAP net income per diluted share to be in the range of $0.94 to $1.00. For fiscal year 2013, the non-GAAP net income per diluted share expectation excludes the purchase accounting adjustment to fair value of approximately $300,000 for deferred revenue, forecasted share based compensation expenses of approximately $9.5 million, estimated amortization of acquired intangible assets of approximately $7.3 million, compensation for post combination services of approximately $1.2 million, restructuring charges of approximately $1.1 million, business development charges of approximately $1.2 million and the related impact of these adjustments on the provision for income taxes of $7.6 million. That concludes our financial discussion this morning. Thank you for joining us, and we look forward to taking your questions.

Steve, go ahead please.

[Operator Instructions] And your first question comes from the line of Mark Kelleher with Dougherty & Company.

Could you talk about gross margins? That’s a pretty impressive number there. Is that a trend we should see? What factors were helping gross margins there?

Sure. In gross margin this quarter, we had probably one unique -- a unique quarter, a one-time quarter, due to the composition of the deals and the customer mix. We experienced about half of that percentage point being attributed to customer mix. The rest is efficiencies that are related to our operations and volumes. So we consider that growth profit margin to be high for this quarter, and we’ll probably be towards a higher end of our long-term operating margin for the full year.

Okay. And on the telco demand side, where are we in the LTE roll-out and the CapEx spending for that roll-out? Are we just in the early stages or has that gone through? Where do you see that rolling out right now?

I think it’s somewhere in between right now. I think we started -- I mean, their early trials were 2, 3 years ago. We were far behind that, but now we are seeing a lot of traction, people coming to us including Tier 1 providers. They had selected somebody else 2, 3 years ago. So I would say we are in the, I won’t say at the peak of the demand, but somewhere in between and at least 1 or 2 more years to go with the continued increase spending in this area.

Okay. And last question, were there any 10% customers in the quarter?

Yes, there was one.

Your next question comes from the line of Chad Bennett with Craig-Hallum.

Just a couple questions. Service provider bookings looked really strong whether you look at them sequentially or year over year. I think they basically doubled either way. And I know you talked about MSOs and your traction there. I guess, was this a unique quarter from a service provider bookings standpoint? Is this kind of dollar run rate for bookings, specifically in service provider sustainable going forward because clearly it jumped up quite a bit. I just wanted your take on that.

Yes, so I think because of the especially very life size and lumpiness of the deals, I mean, usually when you look at the vertical distribution, it’s better to look it on a yearly basis. Obviously, we don’t have the whole year now, and so if you start just looking quarter by quarter, then it looks very much skewed. So I don’t think you should expect that a service provider is -- it’s clear that service provider is doing much better than we expected and the fact that spending is down. But when you -- I think the skew will be much lesser when we finish the year, meaning that we’ll recover some of the federal stuff, pick up the enterprise service provider will continue, but not at this rate. And so long term, we still think a 40%-60% split between service provider and rest of the enterprise.

Okay. And the 10% customer in the quarter, Jean -- I assume that was in the service provider bucket?

Yes, it was.

Okay. And then, just, Jean, or anybody, could you explain the bookings to backlog metrics? Obviously, bookings were -- whether it was new bookings or overall bookings were up. Overall bookings were actually down year over year and new bookings were up slightly year over year. I guess, how did the bookings rhyme with the increase in backlog ending the quarter? Could you just teach me on that?

Just one thing we have to mention before Jean provides the details. One of the reasons we talked about the first half, here’s the special program in place in Q1 and you might have noticed that it was a significantly higher than the previous years. So there were some pull-in from Q2 and that’s partly the reason why the Q2 was sort of flat versus last year. But if you look at year over year for the first half, then you see a better trend. But I’ll let Jean answer the rest of the question.

So the way I think about it is when you look at first half of a first half, the new business bookings actually grew 15%, and then, within that, there is a component that is the product, new business bookings. That also grew about 15%. Year over year, the backlog started almost at 0 at the beginning of the year and it grew to 14.5%. Right now it’s up to 19.5%. So the new business bookings grew 15%. Backlog increased about $5 million in quarter over quarter. But it’s really the revenue increase of almost 30% is more about how much we actually ship. And as we’ve talked in the past, the backlog itself is more a function of the timing of when some of the customers’ orders come in, when the customer wants it and our ability to reply to them within their shipping requirements.

Okay. Last one from me, probably for Jean again. Deferred revenues down about $10 million sequentially. I assume you just have some seasonal run-off in maintenance, but that seems like it’s more than that.

Service revenue related to renewals, you said?

Deferred revenue.

Deferred revs I think were down about $10 million sequentially.

Sure. You’re right. You are correct. It is part of the seasonality. Also, renewals bookings were down a little bit this quarter to the tune of about $3 million to $4 million. There are still a few large renewal deals that are in negotiation that we expect will close probably in the early part of this third quarter.

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

I just had a question. Obviously, the service provider numbers were terrific here. As you look at your pipeline and manage the business throughout the year and into next year, how do you manage the pipeline of revenue for fin services and government? Obviously, you’ve got some spending constraints which are out of your hands, but certainly there’s a lot of uncertainty there. It doesn’t sound like the service provider will continue at the terrific clip it did here in Q2. Are you lowering your assumptions for those other verticals for the remainder of the year? Do you have different programs to focus on that deal flow? Can you just walk us through how we can get comfortable with the verticals outside of the service provider area?

I think basically we don’t look how to manage the pipeline by vertical. We give guidance not based on the share of verticals but the total amount we’re going to do. So I think the way you need to get comfortable is our reiteration of guidance. That pipeline is strong, we can do -- we still feel good about rest of the year despite the economic condition outside. That’s why we’re reiterating the guidance, in fact, raising the low end of the EPS guidance. So that basically talks about our confidence in the pipeline and everything. And as to the managing of the various verticals, I mean, they will keep going up and down because of the large deals we have. You saw $13 million deals just in one quarter, and so we really don’t manage that directly even though we have separate VPs for each of these areas, service provider and enterprise. So we are overall looking at the pipeline for the entire business including service provider as a way to feel good about what we could do for the rest of the year.

Okay. And if we look at the backlog, obviously a strong number here. What is the vertical concentration within that number? Is that similar to how your bookings line up to where it’s -- or is it more heavy in service provider? Can you just kind of walk through that a little bit?

Yes, actually we don’t -- I mean, we don’t talk about that because it’s just not meaningful and it’s all mixed all over the place. And again, it’s like as we said, it keeps going up and down. I don’t think it’s a good representative of our business moving forward.

And the detail that you see in the new business bookings -- that would have included any deals that did not have the opportunity to ship before the end of the quarter. So the new business bookings vertical is representative of all the orders that actually came in for the quarter.

Okay. And Jean, just a clarification. But I thought the backlog was $11 million last quarter. It sounded like you just said it was $14 million, an increase of $5 million sequentially.

You are correct. It was $11 million last quarter. It was $14 million at the end of Q2 FY 2012 for comparisons about how the revenue grew versus new business bookings.

Okay. Understood. And then, Jean, on the OpEx, it was sort of odd to see the sales and marketing expense move lower by that degree on a sequential basis given the metric here in the quarter. Can you walk through that? And then, presumably, that would kick back up here in the back half. But can you just sort of walk through why that came down so much on a sequential basis?

Sure. Basically in sales and marketing, we had some initiatives that we did not execute or fund in Q2 and we expect we will do those in Q3 and Q4. Also, due to the customer mix and the incentive compensations that are related to the different customers of vertical deals we have, that had a decrease in incentive compensation, also. So on operating margin, the operating margins for one time things that we don’t think will continue in the future is almost about 3%.

Three points, okay. And the last question from me, if I could. Can you just walk through why the renewal bookings were down? That just seem to be a little out of step with the trends in your business.

Sure the renewal bookings that we have discussed in the past include multi-year deals. So in FY 2012, we had a few large customers that renewed for -- took advantage of deal negotiations and they renewed for long periods of time. When we do that, they just go right into the new business bookings, and that’s why the service revenue is more smoother because of how we bring that in over these periods. New business bookings this quarter, the simple answer is that there were 2 deals that we are still in customer negotiations with. We do expect that they will close some time in the Q3, and it’s just more timing of when the deal negotiations finish.

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

Regarding the 10% customer, can you tell us if you took all of that in the quarter or did some of it get pushed out into backlog as well?

That order came in probably in the middle of the quarter, and so we had the ability to fulfill the order and ship the entire order. So the portion of that that is related to product revenue and that we actually shipped goes through product revenue. Some of the other components that are in there is maintenance and that will come through our maintenance service revenue line over time.

Okay. And regarding the service provider business in LTE, Anil had talked about this earlier. Could you talk about the visibility? I know there’s a question about where we are in the lifecycle, but could you talk about the actual structure of those deals and orders? And if you have good visibility, are these several quarters of consistent ordering or is it one large order. Could you talk about the visibility that you have on those deals?

Well, I think they are so -- the new -- yes, it’s several quarters of good visibility but for a given customer, I mean, they’re not going to order and they’ll probably order once in a year. So individual orders from a single vendor or a Tier 1 provider is very high. But usually, 1 or 2 big ones will happen each quarter. So we see good visibility definitely for this year but even part of the first half of the next year in terms of the projects going on. And it’s not just U.S. provider. We’re talking about 15 or so Tier 1 providers across the world who are very interested in our solution and are investing in LTE. And we have several conferences coming up which we’ll talk about in the next earnings release of what’s happening there in terms of the level of interest in our products.

Okay. I’m not sure- if I understood that well. So it sounds as if there are several large customers that you have visibility to with several individual larger orders, but the orders are not broken up over time; they come all at once? Is that...

Yes. For a given customer. For one vendor, so it’s like typically they will order and then they’ll order the next one after a year or so. That’s what I was saying. So not all the Tier 1s are going to come in one specific quarter, which is in [indiscernible] provides us good visibility. It’s just timing is such that certain things will happen in one quarter and it looks like lot of things are lined up from a pipeline point of view for the next 4 quarters.

And regarding the government vertical which has been up and down for the company over the past, say, 18 months, do you believe there’s an issue with maybe concentration of large deals in certain agencies or is it a sales execution problem? What would you say it needs to be improved?

Right now, I mean, we don’t see a sales execution problem. There were some changes we did about a year ago. I think it’s largely and mostly on the defense side. We had some very large deals last year. And if you’re comparing with last year, I think that’s a big difference. But still, I think we have chance to recover even though we didn’t see the budget flush, which we normally see in the first half. I think we should be seeing some more activity for the rest of the year.

Your next question comes from line of Matt Robison with Wunderlich Securities.

Anil, can you talk about bookings of mobile compared to cable? It looks like you’re penetrating cable somewhat incrementally. And can you give us a flavor of the mix of in those 2 sectors? And just some background on my question, I’ve seen with some companies we get lumps of cable business whether it’s kind of big, but more mature networks that buy a lot at once and then deploy. They don’t come back for another year sometimes, where the mobile guys, their business can spread over multiple quarters because their networks are growing so much more on a percentage basis.

Well, we see the same thing. I mean, so first, I mean, in terms of lumpiness and frequency of orders, there’s not much difference between mobile and cable MSO. I mean, the MSO area is very small, I mean, quite small compared to the mobile portion. We just started penetrating and talking about that. There are different competitors in that area, and we are having some success. But compared to the overall mobile business, MSO business is still quite small and it’s dominated by smaller number of customers right now even though probably there will be lot of tier 1; more than 10 maybe even 20. We are talking about much smaller numbers at this point in the cable MSO area.

Okay. The background for the decline in service renewals, I know last year the second quarter was kind of a big catch-up in terms of bookings after a rough first quarter last year and it sounds like there were some deals last year that were kind of bringing on some backlog involving multiple year deals in the service renewal standpoint. So is that just kind of a situation where you’ve got a tough comparison this year? I know you talked about some stuff that might have slipped into the current quarter, but can we look at it that way as well as kind of you were trying to fill a hole in the backlog last year and this year you didn’t have that kind of a circumstance?

Well, just a slight correction. Service renewals or renewal bookings do not go into backlogs. They go right into deferred revenue because when we get the order in, we have to take portion in that, pertains to that, so none of it goes into backlog. The backlog..

I wasn’t talking about -- I know your backlog’s only product backlogs.

Right.

For revenue or backlog?

I’ll just take the question offline. Can you give me CapEx and depreciation for the quarter and how many employees are working for you now?

Sure. CapEx for the quarter was about $3 million. Let me just make sure that’s correct. Yes, CapEx, I’m sorry, CapEx for the quarter was about $2 million. So we had cash from operations of $20 million and then $18 million in free cash flow. For employees, head count at this point, we have about around 950 to 960.

So you added about 60 to 65 employees with the acquisition?

With the acquisition of Accanto?

Yes.

With that part of technology acquisition, we only added about 30 to 35 people.

So it’s 60 to 65 overall sequentially, right?

Let me look at my head count. Okay, so at the end of Q2 we had 941 employees in total. At the end of Q1, we had 895. So that is about, say, 35 to 40 people for Accanto, and then the rest of them would be engineers and some administrative and sales people and marketing people.

Your next question comes from the line of Kevin Liu from B. Riley & Co.

Jean, I think you might have alluded to this earlier, but just looking at the service revenue line, the strong sequential uptick, was that where the unusual deal kicked in or is that a good number to use going forward?

The service revenue line?

Yes.

That is probably a good number to use going forward.

Okay. And then, well, in that case maybe if you could give us a little bit more background on the unique nature of the deal. Was it just the fact that it was a large service provider deal or was there something where we should be aware of the terms of how it impacted the numbers?

The large 10% order?

I’m not sure. You had referenced unique deal in the quarter earlier.

Yes.

I’m just trying to pinpoint what sort of impact that might have had in terms of the reported numbers.

Sure. So we had -- so on operating margin and, I’ll just take a minute and walk through it, so it’s clear. On operating margins, we had about a 3% increase, 28% operating margin, 3% one-time items that we do not think will recur. Those include just the unique customer mix and deal structures that happened in this particular quarter. And then on top of that, we had efficiencies within the sales organization and some other items that we don’t think will recur going forward. So that is about the 3% uptick in the operating margin this quarter. In gross profit margin, the customer mix, so about half of the efficiencies that we had in the gross profit line was due to the unique deal structures that we experienced in this Q2.

All right. And then with the 15% uptick in bookings for the first half of this year, I know you guys said you had some more planned initiatives for the back half but what about this relates to hiring additional reps? Do you feel like you have enough coverage? Are there areas such as the sales engineering organization where you plan to ramp up more aggressively with head count?

Yes, I think there are multiple things we are looking at, nothing specific. We are not counting on sales reps to help in this year. So we might do some advanced hiring next quarter but, at this point, we don’t have the mix of hiring. We are behind hiring right now, so that’s what probably Jean was talking about.

On the other hand, our new products from the acquisitions will come online and this increases sales productivity, so that’ll drive some of the back half number.

Got it. And just one last one on the government side. Anil, you just mentioned you still felt confident that some of these deals could still come through. I guess, with the typical budget flush quarter behind us, why do you feel like these sales are in play? What gives you confidence that they ultimately get funded as we make our way through the back half of your fiscal year?

What I was referring was that we’ll still be behind probably versus last year but not as much behind as it looks like right now. So I mean, we do decent business in the second half all the time and we think that will continue. Yes, budget flush makes the first half usually look very good. So we’re disappointed there because of the spending conditions. But what I was saying was that we will recover some of the shortfall in the second half. I mean, there are new budgets and new spending, and so we are hoping that we will get some of those especially on the -- maybe some of it on the civilian side. On the defense side is where we have the biggest shortfall versus last year.

We looked at some of those specific deals that seemed to have slipped into next quarter or beyond, and they are not subject to the budget flush. As Jean pointed out, the strategic projects are funded earlier in the cycle, but the spending is taking various lengths of time. So we believe that because we looked at the deals that that’s the case, that they slipped rather than fell out.

Your next question comes from the line of Patrick Wu [ph] from Battle Road Research.

Just a quick follow-up question to the head count. Is that mostly in the Americas or is that in other regions? Just trying to get a sense of that.

So the head count additions, the majority of the ones from Accanto clearly were based in Italy. The rest of the increases were on a global basis. So we have multiple centers of excellence where we hire engineers and then our sales people are geographically dispersed, also.

Okay. The other question is regarding government, what is your sentiment moving forward? Obviously, possibly maybe with a little more clarity after the election, but just I wanted to get your sense of what you guys are expecting closer to the end of the year and the beginning of the next year.

Well, I think -- like I said, I think that shortfall year over year, percentage-wise, will be smaller than what we see in the first half. Beyond that, I think it’s just we don’t have any more clarity. I think things are going to be tough. Even after the election, it takes time to recover. We have a fiscal year end in March. So -- but we think there are some other projects which are independent of those conditions, and we will have some recovery in the second half versus last year. But it’ll still be smaller than last year.

Your next question comes from the line of Sanjit Singh with Wedbush Securities.

Given some of the consolidation that’s going in the U.S. carrier market, I wanted to get your view on how could that drive the timing of spending going forward.

Well, I think -- so I mean, if you’re talking about the 2 recent ones which are going on, the T-Mobile and U.S. airline, SOFTBANK and Sprint, I mean all of these are our customers. So I think overall there are some time because of consolidation deals are put on hold, but overall I think we’ll have a good advantage because we are already deployed on both sides. And so there will be champions on both sides for us going for NetScout and some place where there is a split decisions like one of the acquirer or acquiree was a competitor, then, yes, there will be some discussion about consolidating vendors. But right now, we don’t see that having any big impact on us for the rest of the fiscal year or even in the early next year, positive or negative.

Great. I just have 2 quick follow-ups. The big drops in accounts receivable this quarter -- just wanted to get some color as to why we saw that big of a decline sequentially. And then competitively, if you talk about the enterprise market and the service provider market, is there any changes going on in the competitive environment that you guys see?

No change. I had mentioned in my portion that we -- I mean we are a -- we’re a longstanding leadership in the enterprise. We announced our new USDM strategy and, towards the end of the year, we’ll be coming up with some new solutions and features that going after a bigger market segment. So I think our situation will be even stronger at that time, but there is generally no change. There are start-ups and some existing mid-tier players, but nothing change. In fact, maybe it’s better for us, slightly better, than versus last year. On the service provider side, I think we are gaining more traction and we were in the top 3 and now we may be number one or top 2 now versus, let’s say, a couple of years ago. So overall, competitive situation is in our favor and that’s what is helping us with these results also.

So in answer to your question about accounts receivable going down sequentially, that mostly just has to do with the timing of when we actually get the orders and ship them. So if you think about the backlog of $14 million that came out of Q1 and we would have shipped that in the beginning of the first week of Q2 and then the spacing and the timing of the other orders, it’s just more a function of items coming in and we being able to collect them before the end of the quarter when we report. That’s the reason for the decrease in accounts receivable sequentially.

[Operator Instructions] And your next question comes from the line of Brian Murphy with Sidoti & Company.

Just a follow-up on the competitive environment. Anil, could you talk about if you’re seeing any competitive response from incumbent vendors in the service provider space? Maybe it becomes stronger on the IP side of the carrier business.

Yes, they are getting stronger, but we are getting even more stronger. And so, yes, we are not winning for the same reason as we were winning 2 years ago, but I can tell you for, at least in couple of cases, 2 years ago we were behind in LTE versus those vendors even though we were the IP leader and we are getting big orders from the Tier 1 providers who had actually selected the incumbent. So yes, competition is increasing. There are some new players now that we have voice solution from Accanto and with a new category of players, there are new players on the MSO side which are, like, the different incumbents. We are the only one who are across the board, so that sometime creates more competition for us but we had a wider audience, also.

And I’m showing there are no further questions at this time. I’ll turn it back over to NetScout for any closing comments.

Okay. Thank you for your time today and your questions. We’ll talk to you again in January. Thanks.

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.