Netscout Systems Inc (NTCT) 2003 Q2 法說會逐字稿

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

Thank you and good afternoon everyone. Welcome to NetScout's second quarter fiscal year 2003 conference call. I will begin our call today with a brief review of our financial results achieved this quarter, followed by a discussion of our operations including project strategy and new products that NetScout is bringing to market. David will then review our financial results for the second quarter of fiscal 2003. First let me introduce you to Cathy Taylor, Director of Investor Relations, who will read the Safe Harbor statement.

Thank you Anil. During the course of this conference call we will be providing you with 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 judgements and that individual judgements may vary.

Forward-looking statements include expressed or implied statements regarding future economic and market conditions, revenues, profitability, growth, delivery and market excesses in NetScout products. It should be clearly understood that the projections on 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 we do. Our company policy is to provide guidance only at certain times in the year such as during the quarterly earnings call. We do not plan to otherwise update that guidance. Actual results may differ materially from what we say today and no-one should assume later in the quarter that the comments we provide today are still valid; they speak only as of today.

Actual results are subject to risk, such as the company's strategic relationships with Cisco Systems and other partners, dependence upon broad-based acceptance of the company's Network Performance Management Solutions, the company's ability to achieve and maintain a high rate of growth, introduction and market acceptance of new products and product enhancements such as probes and software solutions, and the implementation of the company's CDM technology strategy, competitive pricing pressures, reliance on sole-source suppliers, successful expansion and management of direct and indirect distribution channels, and dependence on proprietary technology, as well as risk associated with the continued climate of tight IT spending and further slowdowns or downturns in economic conditions generally and in the market for Network Performance Management Solutions specifically, and risks associated in 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 10-K for the year ended March 31st 2002 and its quarterly report on Form 10-Q for the quarter ended June 30th 2002 on file with the Securities and Exchange Commission.

With that I will turn the call back over to Anil Singhal, our Chief Executive Officer.

Thank you Cathy. Our results for this quarter were as expected and within the range of the guidance that we announced at our last earnings conference call. Our revenue increased slightly from the last quarter and we remained cash flow positive. As stated in our last conference call, our results are a reflection of the continued tight IT spending environment and indicative of the current economic environment overall. Our revenue for this quarter was $17.9 million, compared to last quarter's revenues of $17.8 million and revenue of $19.7 million in the second quarter a year ago.

On a GAAP basis, the net loss for the quarter was $710,000 or 2 cents per share, compared to a net loss of $1.1 million or 4 cents per share for the previous quarter. Our pro forma net loss for the quarter was $373,000 or a 1 cent loss per share, versus a pro forma net loss of $163,000 or 1 cent loss per share in the prior quarter. Our balance sheet remains healthy with no debt and strong cash reserves. In terms of product and marketing strategy, we continue to focus on helping our customers improve their efficiencies of their network infrastructures resulting in improved return on investment and reduced total cost of ownership.

We are pleased to announce another customer who has realized more than $1 million in increased return on investment as a result of using NetScout products. Dial America is a new customer that has realized significant savings within weeks of deploying our nGenius Performance Management System. By developing new valuable information about their network's traffic flows, nGenius allowed them to detect service provider billings that have earned the company over $1 million in savings. This was worth several times their investment in nGenius.

As you may recall, we announced on our last earnings call, our new strategy called CDM, which stands for Common Data Model. CDM has been well received by our customers because it provides an integrated solution, reducing the need for multiple tools and reducing the hidden costs inherent in complex multi-vendor infrastructures. Our first step in implementing our CDM strategy is to begin to unify performance-management functions into a single solution. We have done this in Performance Manager 1.4. We have a steadily increasing number of satisfied customers using Performance Manager 1.4, and David will highlight one of our successful 1.4 customers later on.

We are continuing our work on the next ambitious release of Performance Manager which will be a standard to include data collection from numerous sources in addition to our probes such as rounders, switches and [indiscernible] and will integrate the data into seamless real-time, historical and [indiscernible]. In addition, we are working with our new partners, Extreme, F5 and Foundry to integrate and collate performance data from their network devices.Another indication of our customers' enthusiasm for our new strategy is the strong interest we are seeing in our upcoming first User Conference scheduled between November 5 and 7. This User Conference will be a series of interactive sessions enablingour customers to gain a better understanding of our products while contributing towards strategic direction by way of feedback regarding their network-management problems and challenges. We will discuss our CDM technology direction and feature panel discussions focusing on nGenius ROI delivery and our insight into emerging technologies such as [indiscernible] networks and network security.

We continue to introduce new products to the marketplace. This quarter we added two new members to our Gigabit family of probes: the first Gigabit Ethernet Aggregation Probe and then eight-port Gigabit Ethernet Probe. Our Gigabit Ethernet Aggregation Probe provides visibility of aggregated traffic as it passes through multi-link gigabit EtherChannel circuits while maintaining the ability to manage each connection individually. Our new eight-port Gigabit Probe offers the most cost-effective and simplified approach for troubleshooting high-density gigabit Internet networks. Our new eight-port probe is a simpler solution to today's typical approach of using a combination of distributed protocol analyzers connected to costly metric switches, which is more expensive and requires multiple tool and software systems, adding management complexity.

In combination with our nGenius Performance Management System, the eight-port probe provides superior visibility into multi-switch environments by helping customers quickly troubleshoot and to solve problems as they occur, reducing exposure to lost revenue and lost employee productivity. We also [indiscernible] the new ATM 43/OC-12 probe during this quarter. This new probe is user-configurable to operate at either speed - OC-3 or OC-12 - and will provide investment protection to customers as they migrate to higher-speed networks. Despite the economic environment, we continue to maintain our investment in research and development, producing a growing flow of new product introductions and enhancements. Looking ahead, we have developed a [indiscernible] network solution which has started beta testing. We are planning [indiscernible] for release by the year-end. The same management solution is founded upon our flow-based approach, which has been successful in the LAN and WAN environment and we believe will be equally successful for our Sand environment.

With that I will turn the call over to David.

I would now like to review our quarterly financial results. Our GAAP results are contained in the financial statements included with our press release. I will explain the difference between our pro forma earnings and our GAAP earnings in some detail in a moment. This discussion will be principally focused on pro forma results, which means I will be excluding non-cash charges to our cost and expense that derive principally from our acquisition of NextPoint Networks in July 2000.

As Anil mentioned, our results this quarter were within our previously issued guidance. Revenue for the second fiscal quarter of 2003 was $17.9 million, a modest increase of $100,000 over the first quarter and 9% below our second quarter of fiscal 2002. Our product revenue increased this quarter up 2% from last quarter and down 14% versus a year ago. Service revenue was up 4% over last quarter and up 18% year over year. License and royalty revenue principally from Cisco's resale of our Real-Time Monitor software was down 17% from last quarter, primarily due to lower unit sales of CiscoWorks and down 39% year over year. Revenue from our direct sales force was 47%, up from 35% a year ago. Reseller revenue was 53% of total revenue compared to 65% a year ago.

We are continuing to bolster our sales efforts and broaden our reseller alliances. We are pleased to have announced the addition of Digital China Holdings Ltd, the largest IT product distributor and leading systems integrator in China. Digital China will sell our nGenius system through their extensive network of channel partners in Asia and into the large emerging Chinese technology market. During this quarter we added 38 new customers worldwide, representing 20% of our total orders. Among some of our largest new customers are UBS Warburg, Reliant Resources (a global energy company), Centura Health (a medical provider in Colorado), the Department of Working Pensions in the United Kingdom, Palm Beach County Government of Florida and Hapag-Lloyd (a German shipping conglomerate).

Orders from our install base remain strong, representing 80% of the total this quarter from customers such as Continental Airlines, Verizon, Bank of America, AG Edwards and Visa International. We have 47 deals valued at over $100,000 this quarter. Despite tight IT spending we have four customers with deals over $500,000 this quarter, and one of these was a large, new financial services customer which was a significant win against a major competitor. During the quarter, revenue from the financial services sector was 28% and we saw a strong increase of government orders followed by manufacturing, medical, telecommunications, energy and high tech. One of our large repeat customers this quarter was Chevron Texaco. Chevron Texaco, through their systems integrator, has recently upgraded to our new nGenius Performance Manager 1.4 from CiscoWorks 2000. nGenius delivers Chevron Texaco superior visibility into their global network. Performance Manager 1.4 delivers newly integrated functionality combining historical and real-time information into a seamless analysis. And Chevron Texaco is also a good example of the value our customers achieve from our strategic relationship with OPNET Technologies Incorporated. Chevron Texaco uses nGenius to provide real-time performance data to OPNET'S IT Guru product enabling sophisticated network modeling and application performance analysis.

We are continuing to expand on our partnership with OPNET and to expand our partnering efforts with our complementary solution vendors to bring unique added value to our customers. Bell Canada is another example of a large repeat customer using our nGenius system for their internal network LAN and WAN monitoring, as well as delivering increased value to their managed network service and customers. Bell Canada monitors outsource networks for customer accounts using our nGenius system for in-depth service-level reporting to assure they're meeting agreed upon service levels. Bell Canada has also designed nGenius into several network management offerings, which has added additional value to their managed solutions targeted at large organizations.

International sales revenue was 13% of total revenue, down from 21% last quarter. We experienced new weakness in Europe as the tech spending recession seems to have spread through the Common Market countries. Turning back to our financial picture, our gross profit for the quarter was $13.3 million, down 1% sequentially and down 8% year over year. Gross margin was 74% in the quarter, down two points from last quarter and flat compared to last year. This is principally due to the decline in royalty revenue. However, we expect to remain within our target gross margin range of 72% to 75% going forward.

Pro forma operating expenses in total were $14.4 million, down 2% from last quarter and down 3% year over year. Included in operating expenses is the write-off of a note receivable for over $500,000, which increased G&A expense. Within pro forma operating expenses, research and development was 22% of revenue; sales and marketing was 46% of revenue; G&A was 12%. G&A expense would have been 9% without the write-off I just mentioned. When revenue growth returns, we expect to return to our target business model expense-to-revenue ratios. Pro forma net loss for the quarter was $373,000 versus a pro forma net loss of $163,000 last quarter, down from a pro forma profit of $271,000 a year ago. Our pro forma after-tax loss was reduced by a tax benefit of $369,000 in the quarter, based on our re-estimated taxes for the entire fiscal year. Pro forma net income excludes acquisition and stock-based compensation to costs that are part of our GAAP results. The cost and expense amounts associated with these items are disclosed in parentheses on the face of the GAAP income statement in our press release, and are summarized as supplemental information at the bottom of the statement. The amounts removed from the GAAP line items for the second quarter are approximately $1,000 from cost, $46,000 from research and development, $16,000 from sales and marketing and $2,000 from G&A. Amortization of acquisition costs of $272,000 was also removed to calculate pro forma earnings. Our GAAP net loss for the quarter was $710,000.

Now turning to key balance sheet measures. Cash and marketable securities are $70 million, up $300,000 from last quarter and up $10.1 million from the same period in fiscal 2002, mainly due to positive operating cash flow. Accounts receivable, net of allowances, were $10.2 million compared to $10.6 million last quarter. Days sales outstanding was 49 days for the quarter, down from 51 days in the prior quarter and within our target range of 45-55 days. This decline was due to a reclassification of items in deferred revenue but not yet paid. Inventories were $3.1 million, down 14% from last quarter and down $6.5 million year over year.

And now for our guidance. We are only issuing guidance for the December 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 third quarter, we expect revenue in GAAP and pro forma earnings per share to show little change from the second 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, and disclaim any obligation to provide updates for this information even though our expectations may change during the quarter.

With that, our presentation is concluded and Anil and I will now take your questions. Please go ahead, Therese.

Ladies and gentlemen, if you wish to ask a question please press the 1 on your touch-tone phone at this time. You will hear a tone indicating that you have been placed in a queue and you may remove yourself from that queue at any time by depressing the pound key. If you are on a speakerphone please pick up your handset before pressing the numbers. Once again, if you have a question or comment please press the 1 on your phone at this time. Our first question comes from the line of Bob Lam from Bear Stearns. Please go ahead.

Hi, this is Peter Schubert for Bob. Hi guys. Just a couple of questions. The operating expense was generally down through the quarter through the line items. Can you remind us of the headcount and what changes occurred recently there?

Well Peter, our headcount was relatively flat in the quarter. I think we might have been down one head by quarter end. Operating expenses were down, in part because of some delayed hiring through the quarter and because of some lower activity in travel in sales. We don't expect that operating expense will continue to decline going forward.

OK, and then on the competitive front, can you talk a little about - I don't know if things have changed - Network Associates seem to have an okay quarter for their probes in the US at least. I think they said Europe was also weak. Can you talk about who you see as your big competitor? Do you see more Network Associates or do you consider Concord more?

Well, Peter, like we mentioned last time or in the previous calls, we compete with most of the people including Concord and Network Associates for network management dollars. Direct competition is mainly with Network Associates and I think they are doing quite well against us.

Okay. Then, finally, can you talk about which products are seeing good uptake relative to others? Is it your core probes or is it some of the new higher-speed probes that are sources of new growth?

Mainly the probe area is the higher speed probes, including the new [indiscernible] probes as well as the other probes we have on the gigabit line up. And the Performance Manager, we see some uptake but it is roughly the same as before. So no major change in the portion of revenue from probe versus application.

Okay. And then quickly, can you just comment on demand for the voice-over IP?

Voice-over IP is an enabler to selling our probes. We really don't charge separately for voice-over IP. All of our existing customers get that bundled with our existing solutions. There is a lot of interest but it is still early stages, plus there is no separate revenue for voice-over IP.

Great thanks

Thank you. Our next question comes from the line of Richard Sherman from Janney Montgomery Scott. Please go ahead.

Hey guys, good afternoon. A couple of questions here. Can you provide the percentage of financial services represented in the quarter?

Yes, we had about 28% in the quarter of financial services.

Okay. Good. And then the international revenue was about I think 13% you said.

Yeah.

Was that all Asia? Was there any Europe there?

No, it was not all Asia. It was principally Europe as it has been for us in the past. And although we saw a weakness in Europe, our business didn't go away there. We still have the lion's share of that international revenue from our European business. As we said before, we are aggressively actively building our presence in Asia but that process is still in early stages. Our Digital China announcement was the result of some of that effort of adding new skill people in Asia. And we expect significant growth from that market because it is one of the currently growing markets in network management, we believe. But again, it is still early stages for us.

Maybe about that with Digital China, can you maybe talk about how long a process that was in building that relationship and sort of how you're nurturing it? Do you think it is sort of a three- or four-quarter type of cycle before we see meaningful contribution from Digital China? I don't have your press release on that one - can you give us an idea of how many resellers work with them?

Forming a relationship with a large institution like that, particularly on the other side of the world, takes a while. This one took us about three quarters to get done from the time we figured out it was a good idea and approached them. We have had an announcement with them in their facilities in China, and we do expect that they are going to be actively and aggressively building, doing training and building our relationship, building their expertise in our products. But it is going to take a while for them to ramp up. They've told us they have 6,000 reseller relationships across Asia. Obviously that is a lot of people to train but we expect that Digital China is going to carry much of the selling load once they get up and running. So it'll be several quarters, I'm sure, before we see anything meaningful from them.

Good. Then the last one here was indirect was what 53% looks like. Can you talk about were there any 10% channel partners there and where did you see the most significant contribution?

There was no 10% contributor to the channel sales. Cisco, of course, with reselling our RTM product through CiscoWorks continues to be a large reseller of our product, but excluding that there was no 10% partner. We are continuing to work aggressively with Digital China but also in the US and we are focused on adding resellers that can deliver our products to the government market, which is obviously a growing market these days. And we expect that our reseller channel, because of that focused effort, will continue to grow and may outgrow our direct sales growth. There is no target on that but we would not be surprised to see that. So both internationally where the bulk of our sales are indirect, and in the US where we continue to recruit new channel partners we expect to see growth there.

But, David, you said that with the exception of Cisco there wasn't any major channel partner to that. Did you say that Cisco was 10% or was not 10%?

They were slightly over 10%.

Thank you.

Thank you.

Thank you. And our next question comes from the line of Kimberly Caughey from Parker Hunter. Please go ahead.

Hi. I'd like to have a little more color on the financial services sector. I am assuming that those were mostly commercial banks. Would that be correct?

Commercial banks continue to be the strongest contributors to our financial services line. We have seen sporadic - this is not new this quarter, it has been for a couple of quarters - sporatic activity from investment banks and activity from insurance companies and others like the transaction processes such as Visa International. But the commercial banks continue to be the lion's share of our financial services business [indiscernible].

Did you see any uptake from them in particular in this quarter - I guess from this quarter to last quarter, or is it just kind of random?

No there wasn't an uptake. Our total financial services contribution to business was down this quarter, despite the fact that most of it comes from commercial banks. Commercial banks are obviously the strongest sub-sector in financial services today and we are seeing that in our business.

Right. Okay. Great. The defense area - you do see - this wasn't a one-time only we're good now thanks kind of thing. You see a build-out continuing through the next couple of quarters?

Well I think in government in general we're seeing continuing activity. Obviously the September quarter is a time for the government to spend available budget and that is true of them buying our products as well as other people's. But, clearly, the government spending with the focus on security and security of networks and on reliability and robust management of infrastructure. We expect government spending to continue to be a strong sector for us.

Okay. Talking about running out budgets, do you have any inkling at this point if the commercial sector is going to run out their budgets?

Well I think that is a great question and a lot of people are speculating. We don't have a great insight into it. I think it's fair to say with our guidance that we are not counting on a flushing, as people say, of excess budget dollars. What seems to be happening pretty much across the board is that budgets that were set at the beginning of the year at reasonable levels, although perhaps not at gross levels for many of our enterprise customers have been underspent all year, and we don't see any signs that that underspending will change and that there will be a catch up in the fourth quarter.

Okay, great. Thanks.

Thank you.

If you do have a question or a comment please press the one on your phone at this time. Our next question comes from the line of Victor Valdivia from Hudson River Analytics.

Great. Thank you. Good afternoon. Quick question for David. If you can tell us what the actual cash flow from operations is? You mentioned it was positive, but can you give us the amount?

Sure. Hold on a second.

Sure. And also capex for the quarter?

The cash flow from operations was about $600,000 and capex was about $400,000.

Okay. If you can also comment on the linearity for the quarter.

Sure. Our quarters are generally pretty linear. This one was a little less linear than some. So typically our quarters are 25, 35, 40. This one was slightly more back-end skewed than that, but not a lot.

Okay, so similar to last quarter then?

Yes, that's right.

Okay. And then also regarding your CDM strategy. If you can talk more about that. What kind of feedback are you getting from that and if there's going be any impact on your sales strategy related to the CDM strategy?

Well, we delivered as I mentioned in PM 1.4 we have basically provided part of a broader set which is delivered through that strategy. We still need to do some more work in the next six months to fully leverage that through our sales channel. But, initially, there is a lot of good reaction from the customers on what this will be able to do for them in terms of cost savings and, as I mentioned, hidden costs. Everyone is focusing on how to cut down projects and people budgets and things like that. So they are focusing on obvious costs, but very few people have been able to focus on hidden costs which is the number of people required, number of different products, number of different machines. So, to that end, I think there is a lot of interest in customers believing that this is indeed a major initiative towards that?

And then one last question, regarding the strength that you see in verticals; if you have any insights into where the strength may be coming from - into which verticals they'd be coming from? Do you see any verticals moving ahead on others, in say the next six to twelve months time horizon?

Well not any particular - we see [indiscernible] this sector, as everyone is saying, that's a major area where a lot of money is being spent. But we do not see any particular vertical. We hope that things will start to pick up with some of the things we have coming out in the product area and the financial services sector alone. We are still hoping that that area will pick up because of some of the things we are doing.

Great, thank you.

Thank you. We have no further questions in queue at this time. Please continue.

Thank you very much for coming to our conference call this afternoon. We appreciate your interest in NetScout and we look forward to talking to you again after our third quarter earnings release. Thank you very much.

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