Netscout Systems Inc (NTCT) 2003 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to NetScout third 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 call 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, Ms. 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 third quarter fiscal year 2003 conference call. I will begin our call today with a brief overview of our financial results achieved this quarter, followed by a discussion of our operations, including new products that NetScout released during this quarter. David will then review our financial results for the third quarter of fiscal 2003.

First, let me introduce you to Cathy Taylor, Director of Investor Relations, who would read the safe harbor statement.

Thank you, 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 expressed or implied statements regarding future economic and market conditions, revenues, profitability, growth, delivery and market acceptance in NetScout products. It should be clearly understood that the projections on which we base our guidance and 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 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 risks, such as the company's strategic relationships with Cisco Systems and other partners, dependence upon on 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 same store suppliers, successful expansion and management of direct or indirect distribution channels, and dependence on proprietary technology as well as risk associated with the continued climate of tight IT spending, and further slowdown and downturns in economic conditions, generally, and in the mark of a network [audio gap] performance management solution, specifically, and risen 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. These specific risk and uncertainties are discussed in Netscout's Form 10-K for the year ended March 31, 2002 and its quarterly report on Form 10-Q for the quarter ended September 30, 2002 on file with the Securities and Exchange Commission. And with that I will now 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 revenues increased slightly from last quarter and we remain cash flow positive. Our revenue for this quarter was $18.2m compared to last quarter's revenue of $17.9m, and revenues of $21.5m in the third quarter a year ago. On a GAAP basis, the net loss for the quarter was $328,000 or 1 cent loss per share compared to a net loss of $710,000 or 2 cents per share for the previous quarter. Our pro forma net income for the quarter was $10,000 or 0 cents per share versus a pro forma net loss of $373,000 or 1 cent loss per share in the prior quarter. Once again, we were cash flow positive and our balance sheet remains healthy with no debts and strong cash reserves of $70.3m.

Now on to some operating highlights of the quarter. Our CDM strategy continues to gain momentum and has been well received by our customers. CDM enables a single customer solution for network performance management. Its enthusiastic reception was evidenced by the success of our first user conference, called exchange 2002 that was held in November in Newport, Rhode Island. A wide range of customers attended from different industries, representing more than 40 companies from around the world, including Europe and Asia. The conference agenda contained presentations from NetScout executives and customers, individualized training, discussion groups, panel discussions and one-on-one's with NetScout NGenius and executives. We are pleased with the enthusiasm generated by our CDM technology and with the positive feedback from the conference. Our customers told us that CDM is on target to help them by providing an integrated solution, reducing the need for multiple tools and reducing the hidden costs inherent in complex multi-vendor infrastructure. As part of our CDM single solution initiative, we released two new products in this quarter -- a new fiber channel probe for storage area networks and a patent-pending network security adaptor for improved intrusion detection. Expansion of the NGenius system to include storage network performance is a natural extension of our current capability in managing performance across LAN and WAN environment. The need for visibility into storage traffic [inaudible] is becoming increasingly important to IT managers who are faced with the tasks of managing [Sans] and network attached storage environment to higher utilization and performance objective using equipment from multiple vendors.

Today, many customers do not have performance management tools for their storage network so it is becoming increasingly difficult to manage performance problems that can result in costly service interruption. With our fiber channel probe and performance manager 1.4, IP managers have visibility into storage traffic flows across multi-vendor networks, giving them a single consistent view of how their [Sand] is performing from the NGenius solutions that is managing the rest of their network. The fiber channel probe has all the features of a probe for LAN and WAN environments, including real-time monitoring, historical and trans reporting, and package captured [inaudible] decodes for troubleshooting problems such as multi-vendor inter-operability. And as part of our reliance program we are currently perusing partnerships with the companies in the [Sand] marketplace.

Earlier in the quarter, we also announced the NGenius Network security adapter. This product helps improve the dependability of network based intrusion detection system. The NGenius network security adapter works by allowing any network based intrusion detector system to tap network data streams monitored by network probes. This allows intrusion detection systems to be placed further out to the edge of the network where security attacks typically are more visible, tapping into the [inaudibility] technologies such as [frame relay] and viewing all incoming network traffic.

The primary advantage of our adapter is that it allows network security mangers the ability to tap their detection system into the most relevant data stream, to help reduce false positives and false negatives that arise when processing high volumes of traffic. In addition, our solution includes audited reports and baseline and [inaudible] reporting, which can be used for forensic backup in analyzing intrusion detection alarms when they occur. This is yet another example of the broad applicability and single solution [power] of our CDM strategy. Our customers can use our probes not only to collect flow data for troubleshooting and traffic monitoring, but they can also use the same data streams as an audit trail for security forensics. We are seeing a steadily growing number of satisfied customers using Performance Manager 1.4.

As we mentioned in our last earnings call, we have continued our work on the next generation release of the Performance Manager, which will be extended to include data collections from numerous sources in addition to our probes such as routers, switches, and software agents and will integrate data into seamless real-time historical [inaudible].

Looking forward into 2003, we are very pleased with the customer enthusiasm as we execute on our new CDM strategy. Despite the current economic climate, we are encouraged by the increase in the number of new customers generated in this quarter and the acceptance of our new products in the marketplace. We definitely saw increased sales activity from our customer base this quarter, but it is too soon to tell whether it was just an end-up the year phenomenon. With that, I will turn the call over to David.

Thank you Anil. 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 on a pro forma basis, which means that I will be excluding non-cash charges to cost and expense that derive principally from our acquisition of NextPoint Networks in July 2000.

As Anil mentioned, our result this quarter was within our previously issued guidance. Revenue for the third quarter of 2003 was $18.2m, a modest increase of 1% over second quarter and 15% below third quarter of fiscal 2002. Our product revenue increased this quarter, up 1% from last quarter and down 23% versus the year-ago. Service revenue was up 8% over last quarter and up 19% year-over-year. License and royalty revenue principally from Cisco's resale of our Real Time Monitor Software was down 25% from last quarter.

Revenue from our direct sales force was 49% of total, up from 48% of revenue a year ago. Resale revenue correspondingly was 51% of total revenue compared to 52%. During this quarter, we added 53 new customers worldwide, representing 22% of total orders. This is up from 38 new customers last quarter. Among some of our largest new customers are Sterling Commerce, Sony Electronics, [Scherring Plough], [Coors], [Georgia Pacific], Providien Financial, and Siebel Systems.

Orders from our installed base remained strong with 286 repeat customers representing 78% of order volume this quarter from customers such as, Fidelity Investments, [Johnson Controls], [Sybase], Pfizer, Kaiser Permanente, Timex, and TRW. We had 41 orders received valued over $100,000 this quarter and despite another quarter of tight IT spending we have 5 customers with deals greater than $500,000. During the quarter, we saw orders coming from the financial services sector at 41% followed by medical, hi tech, consumer products, energy, manufacturing, and transportation.

Competitive win orders totaled over $2m in the quarter involving approximately 11 deals against other leading network management centers. One of our new customers this quarter was Sony Electronics. Sony Electronics network technology group selected NetScout's NGenius solution to improve the efficiency of its corporate wide area network. Their needs included improving network planning and performance management and to provide superior data for usage based billing for it's various business units. Sony Electronics selected NetScout for its proven ability as a rich independent data source, and because it provides a wide range of network performance management capabilities in a single solution. Sony's installation is a good example of the strength of NetScout's CDM technology providing customers with the ability to consolidate management function through a single solution, thus reducing tool clutter and realizing savings in operating their network. This was a comparative win for NetScout.

Another new customer this quarter was Sterling Commerce, a subsidiary of FBC Communications and a leading provider of Business-to-Business Solutions. As part of its broad set of capabilities to help enterprises grow their e-business, Sterling Commerce provides outsourcing for its customers B2B transaction processing. With the increasing success of its network servicing offerings, Sterling Commerce wanted to implement proactive performance management capabilities that would both assure services and help contain costs. In a competitive evaluation of several probe companies, Sterling Commerce selected NGenius to proactively mitigate network problems, reduce risks associated with service level contracts, and to streamline management tasks to minimize staffing needs.

One of our largest repeat customers this quarter was from the health care sector. Kaiser Permanente which is the largest not for profit health maintenance organization in US. NetScout was chosen over several large vendors in a comparative bid to supply the performance management solution for Kaiser Permanente's extensive wide area network. KP's network connects and supports an integrated health delivery system consisting of hospitals, research and other types of medical care facilities in nine states across the country. It also enables a vast array of member care services provided to its 8.1m members.

The ability of our Performance Manager 1.4 Solution to ease the task of remotely managing lan traffic and resources including its ability to help Kaiser Permanente's IT organization to improve both planning and day-to-day performance of its wide area network services, resulted in NetScout being chosen as a solution for this multi-phased project.

Turning back to our financial picture, our gross profit for the quarter was $13.6m, up 2% sequentially and down 15% year-over-year. Gross margin was 75% in the quarter, up 1 point over last quarter and compared to last year. This is principally due to higher software and service content. We expect to remain with in our gross margin target of 72-75% going forward. Our revenue from international sales was 16% total revenue up from 13% last quarter. Pro forma operating expenses in total were $14.2m down 1% from last quarter and down 10% year-over-year, due to the spending in headcount constraints that remains in place.

Within pro forma operating expenses, research and development was 22% of revenue. Sales and marketing was 46% of revenue. G&A was 9% of revenue compared to 12% last quarter when we had a right off of a note receivable for over $500,000. When revenue growth returns we expect to return to our target business model expense to revenue ratios. Pro forma net profit for the quarter was $10,000 versus a pro forma net loss of 373,000 last quarter and down from a pro forma profit of 627,000 a year ago. Our pro forma after tax profit was increased by a tax benefit of $382,000 in the quarter based on our re-estimated taxes for the entire fiscal year. Pro forma net income excludes acquisition and stock-based compensation costs that are part of our GAAP results. The cost and expense amounts associated with these items are disclosed in parenthesis on the face of the GAAP income statement in our press release and summarized as supplemental information at the bottom of the statement. The amounts removed from the GAAP line items for the third quarter are approximately $2,000 from cost; $46,000 from research and development; $16,000 from sales and marketing; 2,000 from G&A. The amortization of acquisition cost of $272,000 is also removed to calculate the pro forma earnings. Our GAAP net loss for the quarter was $328,000. Now turning to our Q3 balance sheet measures, cash and marketable securities are $70.3m, up $347,000 from last quarter and up 7.6m from the same period in fiscal 2002 mainly due to positive operating cash flow. Accounts receivable net of allowances was 10.6m compared to 10.2m last quarter. Day sales outstanding were 51 days for the quarter up from 49 days in the prior quarter and within our range of 45-55 days. Inventories were 3.1m, up 1% from last quarter and down 45% year-over-year.

And now for our guidance. We are only issuing guidance for the fourth 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 fourth quarter, we expect revenue to be in the range $18-19m, and pro forma earnings per share to be in the range of breakeven to minus 1 cent, due to near-term increases in operating expenses from higher healthcare costs, and the seasonal effect of employer payroll factors. Our GAAP earnings expectation is in the range of 1-2 cent loss per share. We expect to be cash-neutral in the quarter.

This is the conclusion of our guidance. We plan to provide further guidance at the end of each quarter, in each of our succeeding conference calls. We do not plan to, and disclaim, any obligation to provide updates to this information, even though our expectations may change during the quarter. And now, Anil and I will take your questions. Lynette, would you go ahead, please?

Sure. Ladies and gentlemen, if you wish to ask a question, please press the "1" on your touch-tone phone. You will hear a tone indicating that you have been placed in queue. If you press "1" prior to this announcement, we ask that you please do so again at this time. You may remove yourself from the queue at anytime by pressing the "#" key. If you are using a speakerphone, please pickup your handset before pressing the number. Once again, if you have a question, please press "1" at this time. One moment please for our first question. And it comes from the line of Kim Caughey of Parker Hunter. Your line is open.

Hi. I have couple housekeeping questions, if you don't mind. In the past quarter, I guess Q2, how many deals did you have greater than $500,000 in that quarter?

We had two deals.

Okay. And...

I'm sorry. Kim I corrected. We had four deals.

Oh! Okay. And the competitive wins in eleven deals, who were you competing against, mainly?

Well, we don't disclose specific deal-by-deal competition typically, but our main competitors remain the same. We compete against our friends at Network Associates, occasionally. And sometimes against software-only vendors such as Concrete Communications and in it that the pattern remains the case in this quarter.

All right. And, can you give any color on-- sales were better this quarter. Were people more focused on making sure their networks were working? Are they building out their networks? What was the general tone of why people were doing business with you this quarter?

Kim I can talk about couple of things and David you can add some things. I think what we mentioned earlier that we saw increased sales activity and we are seeing a combination of things and not clear whether people have more budget because of end of year or the deals they are getting it better are [inaudible] to our CDM strategy. So, we see lot more people interested in our message, lot more people doing evaluations, specially to see as a long sale cycle -- that's how we-- measure some of the activities. So that's all we saw. If we repeat [what we see] it as the peak, this quarter, then I think we'll able to tell more about the reasons.

Okay, great. That's all I have.

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

Good afternoon guys.

Hi.

The question is, first one was on Cisco, fell off another 25%. Should we be looking at Cisco essentially going to zero here?

Rich, we have no indication that Cisco's business is going to zero. You know our Cisco contract remains in place. We renewed the contract, as I think we said last quarter. Recently, some of the terms of the contract are different than they were prior and we see some results of that in the lower royalty revenue from Cisco. But our relationship Cisco is unchanged. We may see lower revenue numbers from them as you see here, more typically going forward, but they're still reselling [RTM] and we don't expect that to change in the near-term.

Just a point of clarity-I don't know if I understood completely. Did you say that revenue should go lower from here from Cisco?

I think the levels that you see now are more reflective of the current contract renewal than what you have seen in the past and so revenue levels at this level will fluctuate up and down and you may see some downward pressure.

Where do you think there is a reflection point in which it turns positive again or is there couple of more steps down in which it just slightly got off from the maintenance phase?

Well, we are doing new things. So I think the only -- the positives will be seen in terms of more Cisco [copy] sold of [RTM] not because of pricing reasons. And what David is talking about is some price changes from the contract point of view. So, facing the effects of that since the numbers of copies are not increasing, there is a no positive indication because of that.

Okay. And what would be the catalyst then for the [RTM] to turn back up in terms of number of copies that are being sold?

I think number of copies is direct reflection of the Cisco works 2000 business. If they're more and more copies are sold, than we get modality. We are embedded in Cisco works, as a variety of RTM product is embedded in that.

But in terms of any type of specific factor, are we looking for something -- is there -- another -- [putting that] another software release you are coming up or is it just a tidal fact that Cisco work sales. You guys aren't better so that you guys will capture the royalties. Are there any catalogue for Cisco works to improve and thereby RTM's improve?

I think they are mostly Cisco factors, which will increase the number of copies.

Okay. All right. And then two other ones that I had here. Was there any in the sales headcount? And then the other question was is there any comment you can make about channel partner development of revenue security and storage initiative?

Sales headcount fluctuates up and down as we have people come and go but it's essential flat, Rich, in the quarter. And your second question was --?

The new initiative around security of storage, maybe talk a little bit about [further the] channel partner development activities, you may be creating or started to create around that?

Well, it's too early for that. We have been talking to some companies, but mostly smaller companies. Not necessarily for as a channel for as an integration with our products. So, nothing on the horizon in terms of a channel partner in the security adapter space right know.

Is there something we should, Anil, for in 2003 on a calendar year basis?

Rich, we are -- as you know we have been on the path to expand our alliance partnering program and that initiative continues and that encompasses looking for specific channel partners as well as technology partners. So, yes, you can see more, I can't comment specifically on this area, but yes you should see more in general from us.

Okay. Thanks David.

Thank you.

And, Ladies and Gentlemen, if there are any further questions or comments please press "1" at this time. At this time, Mr. Sommers, we have no further questions. Please continue.

All right. Well, thank you very much all for coming to our third quarter conference call, and we look forward to seeing you 90 days from now or I guess more like a 100 days from now to announce our fourth quarter earnings. Thank you again.

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