Netscout Systems Inc (NTCT) 2003 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to NetScout Systems's first quarter operating results conference call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will be given to you at that time. As a reminder, this conference call is being recorded. With us today is NetScout's President and CEO, Mr. Anil Singhal. He is accompanied by NetScout Systems's Chief Financial Officer, Mr. David Sommers. Also with Mr. Singhal is NetScout's Director of Investor Relations, Ms. Cathy Taylor. At this time, for opening remarks, I would like to turn the conference over to Mr. Singhal. Please go ahead, sir.

Thank you and good afternoon, everyone. Welcome to NetScout's first quarter fiscal year 2003 conference call. After briefly discussing the results of this quarter, I'll be focusing most of my discussion on the broad strategy announcement we made earlier during this week. Since many of you have not had a chance to review our press release or to visit our web site, I will be paraphrasing a large majority of points we made in the press release. David will then review our financial results for the first quarter of fiscal 2003. First, let me introduce you to Cathy Taylor, Director of Investor Relations, who will read the safe harbor statement.

Thanks youk, Anil. During the course of this conference call, we will be providing you with a discussion of the factors we currently anticipate that may influence our results going forward. Before doing so, we want to emphasize that these forward-looking statements may involve judgment, and that individual judgments may vary. Forward-looking statements include express or implied statements regarding future economic and market conditions, revenues, profitability, growth, delivery and market acceptance of NetScout's products. It should be clearly understood that the projections in which we base our guidance 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 otherwise update that guidance. Actual results may differ substantially than what we say today, and no one should assume later in the quarter that the comments we provide today are valid. They speak only as of today. Actual results are subject to risks such as the competitive environment, changes in the development of our technology, changes in NetScout's strategic relationships with Cisco Systems and other partners, downturns in economic market conditions, the pace of introduction of new products and product enhancements, acceptance of NetScout's Solutions and new market segments, competitive pricing pressures, reliance on sole source suppliers, successful management and expansion of direct and indirect distribution channels, our ability to grow our direct sales force and our ability to achieve our business model projections relating to growth and operating margins. These and other specific factors could change, causing our projections not to be achieved. Specific risks and uncertainties are discussed in NetScout's Form 10K for the year ended March 31st, 2002 on file with the Securities and Exchange Commission. And with that, I'll now turn the call back over to Anil Singhal, our Chief Executive Officer.

Thank you, Cathy. Our results for this quarter were within the lower guidance range that we announced in early June. The results were indicative of the current economic environment and continued downsize in spending that resulted in small orders and extended sales cycles compared to previous quarters. Our revenue for the quarter was $70.8 million, a sequential decrease of 32% of revenue or $32.9 million last quarter, 22% decrease for revenue or $82 million dollars in the first quarter this year ago. Pro forma net loss for the quarter was $163,000 or one cent loss per pro forma diluted share versus the pro forma net income of $1.4 million or five cents per pro forma diluted share in the previous quarter. And now on to our strategy announcement. As you know, on Monday we announced a new strategy and vision for consolidating network performance management through a single solution, the continued performance management System. This strategy is based upon a new (inaudible) technology that we developed called the commendator model or CDM, which I'll explain in more detail. Our new CDM technology is our solution to solving one of the biggest problems enterprises are faced with today, and that problem is clutter. Our customers are telling us that despite their best efforts to date, they're forced to use a multitude of different performance management tools for different graphic types. For example, they are using different tools to monitor data, voice and web content running across the network. They're also using different tools to collect data from a variety of data sources such as router, switches and probes. Furthermore, there this added complexity of using different tools to perform performance management functions such as reporting, troubleshooting, monitoring, protocol analysis and service level management. All of these different tools are creating clutter, and the result is too much data with too little information. 1 More importantly, these different tools have hidden costs associated with them, such as added infrastructure costs and added voice mail costs. In the past decade, there have been at least two major attempts at solving this problem. One is the umbrella management system or sometimes referred to as the framework system approach, which places the common interface over a set of applications, but the user is still faced with having to sort through the clutter and integrate the data himself in order to make informed decisions. The second approach, sometimes referred to by acquisitions, uses three separate loosely coupled applications that is supposed to provide an integrated solution, but in reality, the user is still faced with the same clutter of tools except that it's just from one vendor. Our strategy is to substantially reduce or eliminate the data and tool clutter for our customer and lower the total cost of ownership by offering them a single architectural solution as the basis to consolidate their point performance management tools. Our CDM technology is an advanced slow base approach for integrating performance data across the network. We have been using this same slow base approach today for simply (inaudible) by integrating traffic flow data from expanded network technologies such as gigabyte datamax, ABM, frame release and from Cisco devices into consistent analysis views and support. This was incorporated into what was recently announced in Genius Performance Manager Version 1.4, which for the first time combined the task for realtime monitoring, historical reporting, troubleshooting, and protocol based on traffic information collected from probes, and last, which is for voice rapid data traffic all in a single product. CDM direction is built on solid foundation, which includes our new CDM technology, especially in some of our largest customers, or important in many of the beginning developments and our (inaudible) from solid makes us a pioneer in the network performance management phase. The direction we have unwielded this week takes a completely different approach to resolving the entire clutter. Unlike other vendors, we are starting with the foundation of the commendator model. One phase of application we (inaudible) we have for many years. This technology gives us network-like performance information necessary to consolidate all performance management functions across the infrastructure. With nGenius in place, our customers will realize enormous savings through reducing the human effort required for planning, monitoring and troubleshooting the network, eventually creating network performance by optimizing the use of the existing infrastructure. We will be implementing our now series with a series of the release of a single software application called Performance Manager and through a new formed (inaudible). The first version of Performance Manager was Version 1.4 that was released in May. Over the next mine months, Performance Manager will be expanded to cover (inaudible) network using a new NetScout probe. During the same period, Performance Manager will expand the range of network devices through partnerships with other infrastructure vendors. The unit Performance Manager will be further extended to integrate the full functionality of the capacity planner and application service level manage of products into BM by introducing new intelligence performance alarm and by implementing a comprehensive self-management capability into the nGenius system. As of particular releases and multi-body data tools will enhance the user productivity by providing increasing automation of all performance management tasks. To leverage our new services, we also announced on Monday our new nGenius alliance program. The first step in this program is to extend the scope and reach of nGenius beyond Cisco devices and NetScout's probes to collect performance data from hardware devices which complement the data collected from NetScout probes. In addition to our existing partnership with Cisco Systems, we are happy to announce that we are partnering with FY Networks and Nexpoint Networks, and Extreme Networks. We are pleased that this family has been well received by the markets and industry analysts as well as our customers. As instructed from enterprise management associates published a positive report stating that he believes our CDM technology will be better for the industry evolution as customers seek to consolidate and integrate existing management investment. Please visit our web site for more information about CDM and comments from other analysts. Now I'll turn the call over to David.

Thank you, Anil. I would now like to review our quarterly financial results. This discussion will be principally on a pro forma or cash basis, which means I will be excluding noncash charges to cost and expense that derive principally from our acquisition of Nexpoint Network in July, 2000. Our GAAP results are contained in the financial statements included with the press release. I'll explain the difference between our pro forma earnings and our GAAP earnings in some detail in a moment. This quarter was challenging. Our product revenue declined as we experienced constrained IT spending that resulted in smaller orders and extended sales cycles, as Anil mentioned. However, we managed costs and operating expenses down during the quarter to mitigate the impact of the revenue decline. As Anil mentioned, revenue from the first fiscal quarter of 2003 was 17.8 million, a 22% increase from our fourth quarter and slightly below first quarter fiscal 2002. Our product revenue decreased this quarter, down 31% from last quarter but virtually unchanged versus a year ago. Service revenue was down 4% from last quarter but up 22% year over near. License and royalty revenue principally from Cisco's resale of our realtime monitor software was down 5% from last quarter, and down 41% year onever year, primarily because of lower unit sales at Cisco Works. Revenue from our direct sales force was 47% of the total, up from 31% of revenue a year ago. Reseller revenue was 53% of the total compared to 69% a year ago. Within the reseller segment, revenue through Cisco accounted for 14% of total revenue unchanged from last quarter but down from 52% one year ago. During the quarter we added 29 new customers worldwide. Among these new customers are XM Satellite Radio, El Qaedo University, Borders, Franc and Opal AG. Orders from our install base remain strong, representing 90% of the total this quarter from customers such as VISA, Wachovia, Oracle, Johnson Controls, The Gap and B and Q TLC. Despite widespread spending constraints, significant numbers of our existing customers are coming back to us with large follow on implementations, just as we've seen in the past. This quarter we had several repeat business deals over $400,000. In the first quarter, revenue from our traditionally strong financial services sector was 33% of the total, down from 40% the prior quarter. We had a strong showing coming from high tech, government, telecommunications, manufacturing and retail industries. Turning to international sales, revenue was 21% of 2 total, up from 19% last quarter. We continue to see results with our international channel partners program. For example, 1/3 of all our new customers this quarter were international. Turning back to our financial picture, our gross profit for the quarter was $13.5 million, down 20% sequentially, but up 5% year over year. Gross margin improved to 76% in the quarter, up 2 points over last quarter and up 6 points over last year. Pro forma operating expenses in total were $14.7 million, down 10% from last quarter and down 1% year over year. Head count rose by 3 from the previous quarter, as we began to invest as we had said in sales and support in order to drive growth. As of the end of the quarter, we had added eight new quota carrying sales people. However, during the quarter. As we saw that we were not going to achieve our planned growth, we stoped our new hiring, capped head count, and further tightened our expense controls. Within pro forma operating expenses, research and development was 23% of revenue, sales and marketing 47%, G and A 12%. When revenue growth returns, we expect a return to our target business model expense-to-revenue ratio. Pro forma net loss for the quarter was $163,000, down from net income of $1.4 million last quarter and up from a loss of $931,000 a year ago. Our pro forma tax loss was reduced this quarter by a tax benefit of $691,000, based on our reestimated taxes for the entire fiscal year. Pro forma net income excludes acquisition and stock-based compensation costs that are part of our GAAP results. The cost and expense amounts associated with these Our GAAP net loss for the quarter was $1.1 million. We expect aggregate stock based compensation will drop from the total of $712,000 in the first quarter to approximately $65,000 during the next two quarters, and then decline slowly beyond Q3. We also expect amortization of acquisition costs will continue to run at approximately $272,000 per quarter for the remainder of the fiscal year. We will continue to discuss both GAAP and our straight forward pro forma financial results throughout the year. Turning now to key balance sheet measures, cash and marketable securities are $69.7 million, up $404,000 from last quarter and up 9.1 million from the same period of fiscal 2002, mainly due to positive operating cash flow. Accounts receivable net of allowances were 10.6 million, down from 12.9 million last quarter. Days sales outstanding was 51 days for the quarter, up from 48 days in the prior quarter and within our target range of 45 to 55 days. Inventories were 3.6 million, down 2% from last quarter and down from 8.3 million year onever year and now for our guidance. We're only issuing guidance for the September quarter today. Our near-term expectations are based on the current climate of tight enterprise IT spending and the uncertain timing of the impact of improving general economic conditions and on our view of our sales pipeline. For our second quarter, we expect revenue and pro forma earnings per share to show little change from the first quarter. We expect to be cash neutral in the quarter. This is the conclusion of our guidance. We plan to provide further guidance after the end of each quarter in our succeeding conference calls. We do not plan to or disclaim any obligation to provide updates to this information even though our expectations may change during the quarter, and now I'll turn the back over to Anil to close.

Thank you, David. Looking forward into 2003 and beyond, we are very excited about our growth prospects as we execute on our new strategy despite the tough economic climate. We believe that we have come up with a unique and compelling solution to one of the most important problems facing the network management industry. The resulting solution will allow us to grow both in market size as well as our market share of the network performance management space. We are planning to back this strategy by introducing a large number of new products and new partnerships at a faster pace than ever before during the current fiscal year. We hope that you'll stay tuned for these announcements and as we report on the progress we are making as a result of our new strategies. Thank you, and now I would like to turn the call over to questions that you might have.

Thank you. Ladies and gentlemen, if you wish to ask a question, please press the one on your touch tone phone. You'll hear a tone indicating that you have been placed in queue and you may remove yourself from queue at any time by pressing the pound key. If you're using a speak phone phone, please pick up your hand set before pressing the number one. One moment, please, for the first question. We have a question from Victor Valdevia, Hudson River Analysts. Please go ahead.

Good afternoon. A couple of questions, first a couple of questions on financials. If you can, if you have the cash flow from operations and your capital expenditures for the quarter?

If you'll wait one second, we'll dig those numbers up.

In the meantime, another question for Anil. Regarding the alliance program, can you share with us how you're thinking about how you're going to use this program to generate the new joint sale opportunities with your partners?

Well, first of all, there is a lot of data, a lot of useful data available in other range of devices whether it is Extreme or Foundry, but there is no good application to use the data because it's just too much work, and so what we are doing with our CDM technology is really mapped out into a common framework which can be used to leverage against applications we already have, and these customers will have a mix of environments, mix of vendors, mix of devices, as well as NetScout probes, and that will create a lot of joint opportunities because all departments we've ever known we have really not engaged in any joint sales or have not leveraged data from the devices yet.

So your sales force will be working closely with their sales force; is that part of the plan?

Well, that's - I mean, that remains to be seen. Right now, we are just trying to finish all of the technology and the product integration part. So depending on where we want to take this relationship and how we can work together, that needs to be determined.

Great. Can you offer us a little update on how your new version of the Performance Manager Version 1.4 is being accepted?

First of all, we biggest thing we had down in that is combined historical reporting and realtime monitoring and analysis in a single product, and that has been one of the hard questions for all of our big customers. So it has been very well received despite the issues in the current quarters, and a lot of customers are very excited about it.

Can you also comment on how ASPs are changing, maybe you can change share with us what the level of the ASPs is now, the average selling price of a deal?

Average selling price declined in the quarter, our average selling price of a deal is down in the 80 to $90,000 range this 3 quarter. It was above $100,000 last quarter.

Great, and have you found the other?

Yup, cap.ex. was about $650,000 in the quarter, and the cash from operations was 1.1 million.

Great, thank you very much.

Thank you.

And we have a question from Kim Kaheave with Parker Hunter. Please go ahead.

Hi, I was wondering if you could give some color on the $3 million in competitive wins, namely, who are they against, hardware or software?

Well, we compete against a range of competitors in both hardware and software. Our - flipping to the data briefly, thank you. Our competitive wins were pretty much across the board. We had no single competitor accounted for more than a third of the total, and we continued to compete very well against the principal other hardware vendor, Network Associates.

And my final is, you didn't address this in this call we had, it's the new high speed probes. Are they nearing completion? Are they out there?

Well, what we have been doing, Kim, several high speed probes. The fact that the sonic probe is out there and we had released maybe in working the similar thing on the ABX side, but the gigabyte side we are not necessarily increasing the board speed but we're increasing the density, so overall speed of the probe is going to double. So all this is going to happen in this fiscal the highest speed probe, but we are offering dual speed probes. So you can go over there, for example, the OC3 speed probe, and then when you upgrade your band width, you just can simply flip a software switch in the probe to go to OC12. That I think is going to be a very exciting thing for the customers.

Oh yeah, absolutely. All right, thanks.

Thank you, Kim.

We have a question from Richard Sherman with Jenny Montgomery Scott. Please go ahead.

Good afternoon, guys. A question here on the financial services industry. Dave, I think you noted the decline in business for financial services from, if I remember it correctly, 43% to about 33%?

It was 40 to 33.

Okay, 40 to 33. It looks like that's about, what $3.5 million worth of business that disappeared from financial services, and so going forward, and it looks like that represents the vast majority of the decline in the quarter. Going forward - and you've given guidance sort of towards a flat quarter here in September. What's your expectation from the financial services component? Are you expecting that to increase again this quarter or are you expecting that to continue to decline?

Well, we don't have specific expectations for the sectors that we talked about, Rich, but I think it's fair to say that the financial services on the investment banking side has been disappointing for a long time. Commercial banking has taken up a lot of the slack for us recently since the investment banking doldrums, and commercial banking has subsided a little bit for us. We're still seeing activity on all, in all subsectors, but we're seeing a little less in commercial banking and some of the interesting big deals we've had with transaction processors like VISA haven't reoccurred. So we're hoping that the events of that have troubled commercial banks recently and the equity markets that drive investment banking will start to pick up those customers, those financial service segments for us, but I wouldn't say we expect it in this quarter.

Okay, and then the new partnering program, where does Cisco fall into that effort with the others like Extreme and Foundry?

I think we are trying to do some things which we were able to do successfully with Cisco. So there is no change in the relationship with Cisco. In fact, we are formalizing some of the things which we were not pushing for with other Cisco devices. We did a difficult job with NetScout probe with tour application inside Cisco Works, but we were not pushing for integrating all of this stuff with other devices from Cisco, which includes the routers and other things. So with this new strategy, we have that embracing also. So when we talk about other partners, we have only made assumptions that we'll do all of these things. We're already doing that with Cisco devices also.

Right, okay, those are my questions, thank you.

Let me just add to that, Rich, that Cisco continues to resell with the monitor, no change in that relationship.

Thank you, David.

And we have a question from Peter Schubert with Bear Stearns. Please go ahead.

Hi guys. Just a follow-up on the first question on the new partnership program. It does seem to make sense that there is a need for that type of solution, but can you give us a better idea of how you expect to quantify or how you expect to monotize the relationship over, say the next four to six quarters, do you expect some period of slow rampup or how do you look at it as an opportunity in terms of impact to the top line?

I think we don't have quantifiable impact right now. I think our customers are really excited about it and quantify the benefit to them, but I don't think we can quantify at this time that that is a revenue benefit to us, and we also mentioned that we were going to start seeing the impact of the strategy starting in 2003. So it's just too early to probe me on some of the questions you're asking.

Okay, and then the gross margin jumped a little bit, and it seems to be moving up, and you've sort of guided it relatively stable, but it keeps relatively bouyant. Is that something we can expect to continue or -

No, we're not going to be in that direction, Peter, because as you can see from our revenue mix, when you get a chance to take a close look, product revenue, which is our lowest margin revenue component, was down in relation to what we expect in the future and what we expect and what we've seen in the past. So overall, while the revenue mix, if it stays about where it is, then it's reasonable to be close to the at the high end of our target gross margin range of 72 to 75, but as soon as revenue growth, sales growth resumes, we expect those margins to come back down into the range.

Fair enough, and then one final general question. It seems out there that there's, the budgets that were set for this year are, you know, are not, were sort of not on track to be spent generally across the enterprises. What do you guys see in terms of the budget spending and do you see budgets being clearly spent or do you think by come Q4 that the year will close with a lot of money that just hasn't been put to work?

Well, we can tell you what happened in the last quarter, that people are 4 spending less than they have budgeted for. Whether they will choose to spend on the remainder toward the end of the year is not clear.

I think there are two schools of thought on that. I don't think customers themselves actually know. So I don't think we can draw an aggregate conclusion to that question. We'd be interested in your view.

That's a good question, you're right, there are two schools. I'm just trying to see where you guys see things but that's okay. Thanks very much.

Sure, okay.

And we have a question from the line of Victor Volpe with Wells Fargo. Please go ahead.

How are you doing guys. We spoke just a second ago about your gross margin increasing as a result of lower product sales because it's a low margin product for you guys. Is there anything else you're doing to drive this number up or you have been doing in the past?

Over the last twelve months as we had changed our relationship, our reselling relationship for our hardware with Cisco, we picked up that business through, primarily through our direct channel, and that's principally at higher margins. So we have seen it in fact a year ago in this quarter. We changed our margin guidance and raised it two points, and we're still comfortable that the new guidance range of 72 to 75 is about right when we get back to a product service royalty mix that we think is more long-term for us.

Okay, sounds good. Thanks a lot.

Sorry, that's really the only how the last three weeks in the quarter turned out and if there's any pickup in July?

Yeah, we can give you some information about that. The quarter for us, obviously you all know that we changed our guidance early in June, so we saw this issue arising very early in the quarter. Our quarter was slightly more skewed to the back end this quarter than normal, but our quarters are very unskewed. So our skew this quarter, which was the effect that really drove DSL up a couple days this quarter was the June quarter was in the range of 40 plus percent this quarter instead of between 35 and 40, where it sometimes is. So we didn't see a huge rush in shipments and bookings at the end of the June. What we did see throughout the quarter was deals that we saw, and we had insight to close in the quarter at the beginning of the quarter start to get deferred, not cancelled, not what our customers are telling us, but as events happened, as the approval process went higher and higher in the enterprise, things got deferred. Questions were asked about why they had to do things now, why the project had to go through now, and so we saw an amazing amount of that in the quarter. Projects which were, as Anil had alluded to earlier, budgeted for, the budget release was not approved. So we saw that, and those deals we think are still alive and give us some confidence about the guidance for the September quarter, flat though it is.

Thanks.

Thank you.

And we have a question from Dion Cornet with First Analysis. Please go ahead.

Hi, Anil, it's Dionne Cornet and Maury Kramer here. As you sort of elevate your pitch for your CDM product and I pull of your web site verbiage along with some other companies like Hughes HP, NCA, the product sounds similar. Could you maybe describe in a little bit more detail your strategy for going to market with CDM and how you intend to attack these other companies which in some cases have even more customers, more partners and deeper traction in a sort of major majors market already.

First of all, we don't need to change the sales strategy with what we are doing. I think the problem is the same. The message is the same, but the solution is very different, and I think customers will see through it, and all the customers we have been talking to have been very excited about the thing that these kinds of things, many want to solve this clutter problem. We have to work from the ground up rather than it being an afterthought. You need a customer-centric strategy which we are going to work on the customer's problem and that create right acceptance of the product as well as a whole net management initiative. So we have not - obviously we need to do more marketing and messaging around it, but we have not, we don't see any big change in our selling strategy as of this announcement.

So if I could paraphrase you, just to make sure I understand this correctly, it would be your view that because your technology uses a different approach than what some of these other companies are using that that, in your mind, superiors technological approach should lead to success in this market and the other factors I mentioned?

I think our approach to the technology and result in the product obviously combined, even which has been validated by many of our large customers who have this problem already.

Could you give me a quantitative number of how many beta customers you have for CDM already?

CDM is actually in a peromance major approach, but for BM when we come out with the next version of BM, they may have a long list of beta customers. I don't remember at one point how many we had.

Is it two, half dozen, twenty-four, do you have a ballpark?

I would say ten plus, something like that.

Well, thank you very much and best of luck with it.

Thanks.

And Mr. Somers and Mr. Singhal, there are no further questions at this time.

Thank you, and we'll join you again at the next quarterly conference call.

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