Netezza F2Q08 (Qtr End 7/31/07) Earnings Call Transcript

Executives

Patrick J. Scannell, Jr. - Chief Financial Officer, Senior Vice President, Treasurer, Secretary

Jitendra Saxena - Chief Executive Officer, Co-founder and Director

James P. Baum - President, Chief Operating Officer, Director

Analysts

Robert Semple - Credit Suisse

Kathryn Huberty - Morgan Stanley

Kevin Hunt - Thomas Weisel Partners

Glenn Hanus - Needham & Company

TRANSCRIPT SPONSOR

Netezza Corporation (NZ) F2Q08 Earnings Call August 23, 2007 4:30 PM ET

Operator

Good day, ladies and gentlemen and welcome to the Netezza second quarter 2008 earnings conference call. (Operator Instructions) At this time, I would now like to turn the call over to Mr. Pat Scannell, Senior Vice President and Chief Financial Officer. Please proceed, sir.

Patrick J. Scannell, Jr.

Thank you. Good afternoon, everyone and thank you for joining us on our first earnings release conference call as a public company. Jit, Jim and I will take you through our financial results for our quarter ended July 31, 2007, which is our second quarter of our fiscal year 2008, and will give you color on the trends in our business for the next quarter and for the balance of the year.

Before I turn the call over to Jit, there are some important points to cover. On this conference call, we will only be referencing GAAP financial information as provided in the press release we issued at the close of market today announcing our Q2 results. However, stock compensation expense has been broken out separately for those that want to assess the performance of the business excluding stock compensation expense.

The press release is available on the home page of the investor relations section of our website at www.netezza.com, and the webcast of this call will be archived in the same section.

In addition, a recording of the conference call will be available later this evening and will be available for two weeks. The replay can be accessed by dialing 888-286-8010 for participants in the United States and by dialing 617-801-6888 for participants outside the United States. The pass code for the replay is 92918343. This information is also included in the press release.

Some of the statements made on this call will be forward-looking statements, including our comments on financial performance, operating performance, the growth of our business and our financial expectations. These statements are not guarantees of future performance. They are based on our expectations as of today, August 23, 2007, and assumptions which are inherently subject to uncertainties, risks and changes in circumstances that are difficult to predict. Actual results and the timing of the outcome of events may differ materially from those expressed or implied in these forward-looking statements for a variety of reasons and factors, which may be discussed on the call today or described in our press release, or in reports and documents filed with the SEC, including our most recently filed prospectus.

We do not undertake any obligation to update any forward-looking statements or other statements made during the call.

Now let me turn it over to Jit Saxena, our Chief Executive Officer, for his overview and commentary on the quarter.

TRANSCRIPT SPONSOR

Research 2.0 picked up coverage of Netezza with the IPO. The company is seeing strong near-term business momentum thanks to the clear ROI from high performance data warehouse technologies.

Although companies like Teradata loom on the competitive front, Netezza is in a strong position.

We provide ongoing research coverage and updates on Netezza and the data management space aimed at senior business managers and institutional investors. Thanks to our lightweight business model we can delivery these updates via subscription and individually at Research & Markets.

Free updates are available via our blog and mailing list.

To sponsor a Seeking Alpha transcript click here.

Jitendra Saxena

Thanks, Pat. Good afternoon. We are very pleased with our results for our second fiscal quarter. Based on what we saw during the last quarter and what we are currently seeing, I would like to make the following comments.

First, demand from both our existing customers and from new customers continues to be very good. Second, our pipeline for future business is very robust and our visibility in terms of our business is getting better. Third, our value proposition based on our price performance and cost of ownership is getting stronger. Fourth, based on the strength of our pipeline, we continue to increase our investments in product development and our distribution channels.

Fifth, we continue to see evidence that the market for our products and the applications in which our customers are deploying our products is quite large and that we are still in the fairly early stages of this large and growing market.

I would like to have Jim Baum, our President and Chief Operating Officer, to elaborate on each one of these observations. Jim.

James P. Baum

Thank you, Jit and good afternoon, everyone. As you can see from our results, demand for our data warehouse appliances remained strong. During the quarter, we continued to increase penetration in our key vertical markets, including significant wins in financial services, retail, e-business, government intelligence, telecommunications, and the outsourcing analytics providers who act as a channel for us.

We are seeing continued purchases from our customer base while we also added eight new customers in the quarter. Our customer base represents a significant growth opportunity for Netezza and we saw large orders from key existing accounts in financial services and e-business, further validating our value proposition. We are pleased with the eight new accounts we closed in the quarter, as each represents substantial potential for additional product sales in the future.

Based on deal sizes and the way our sales cycles tend to operate, we expect to see between six and 15 new accounts per quarter as these cycles reach maturity. Our investment in international distribution performed well during the quarter and represents growing momentum. We closed key new accounts in the U.K. as well as Australia and our international pipeline is strong.

As we look ahead to future quarters, our pipeline and visibility are strong across all aspects of our business. We measure our visibility using a coverage metric, which compares our objectives with our sales force’s pipeline of qualified opportunities. As we look toward the rest of FY08 and into FY09, our coverage metrics have improved from historical levels and are consistent with what we believe they need to be to achieve our goals.

We are seeing improvements in coverage across all aspects of the business, whether we evaluate it by vertical market or by geography. We believe this is representative of both the maturing of our sales force as well as an increasing acceptance of data warehousing appliances in the data center.

Our value proposition based on performance and total cost of ownership continues to resonate well with the market. We differentiate our product on price performance and total cost of ownership, which is largely driven by the simplicity of the deployment and use of the Netezza platform.

During the quarter, we competed with the vendors we have historically seen, Teradata, Oracle, and IBM. Our value proposition remains strong against these competitors and we’ve seen no weakening of our ability to significantly outperform their solutions at a lower total cost of ownership.

The dynamics of our market have not substantially changed and the retail segment continues to be the most competitive vertical market we participate in. Our selling model is one of proving our value proposition in the customer’s environment through a proof-of-concept, where the results convincingly differentiate our product in the customer’s own environment. As a result, our proof-of-concept conversion rate remains above 80%.

While we do occasionally see one of the new data warehousing entrants enter into one of our deals, none of them appear to have real traction in the market at large and none of them have the architectural advantages of Netezza’s appliance.

Now, based on the strength of our pipeline, we are continuing investments in product development and distribution. Our engineering team has recently announced Release 4.0 of our platform. This release is a software-only upgrade for our appliance that provides our customers with a 2X performance increase over the previous version of the system.

Among other obvious benefits of these performance enhancements, this version of the platform allows us to more easily deploy our appliances into data warehouse initiatives that are characterized by large numbers of concurrent users, extending the number and types of applications where our customers can use our solution.

In addition, Release 4.0 contains key features that will allow our appliances to better integrate into our customers’ enterprise data management environment, further reducing the total cost of ownership.

Our investment in product development will bear additional fruit in the first quarter of ’08, with another software-only release that will again double the performance of our system. We continue to believe that our product architecture has significant performance upside and our engineering team is hard at work, further innovating to exploit these advantages.

Our investments in direct distribution will further fill out our presence in international markets and deepen our presence in North American markets. We are in the process of expanding into Germany and Southeast Asia, and envision further investment in both European and Asian geographies through the end of this year.

Given that currently our business is primarily driven through our direct sales channel, our business growth is proportional to our sales team’s growth in headcount. As such, our strategy remains to invest prudently in sales capacity to meet our growth targets, while we aggressively focus on building and tuning a world-class sales organization.

We continue to see evidence that the market for our products is quite large and the applications in which our customers are deploying our products suggests that we are still in the early stages of the development of this market. Given the importance of business analytics to the competitiveness of any enterprise, and the technological innovations being brought to the market by Netezza and others, we see continued reason to have confidence in market growth and expansion. In fact, we believe that the conventional definition of the enterprise data warehouse is changing and that the market will seek the benefits of new generations of applications that perform key business analytics on the ever-increasing data assets our customers and prospects collect.

Early signs that we see include accelerated activity with our business intelligence and analytics partners and the atypical deployments of our technology with several of our forward-thinking clients.

For example, corporate express has recently announced that it will deploy a self-service application to its customers that will provide web-based business intelligence to 10,000 users. Netezza's platform was chosen as the basis for this application over Oracle. This example demonstrates the idea that companies are making data and analytics accessible to large numbers of users, sometimes even outside the firewall, a trend we believe will become more widespread.

Another example is Guy Carpenter, a re-insurance intermediary and division of Marsh & McLennan. Guy Carpenter recently brought an innovative risk modeling solution to market based on Netezza's data warehouse appliance. This solution, which provides access to near real-time exposure data, is tightly integrated with Guy Carpenter’s risk management expertise, enabling insurance executives to make faster, better informed risk management decisions.

The speed with which the sophisticated analytics required to assess insurance risk can be completed substantially drives competitiveness of companies like Guy Carpenter. These solutions are not typically deployed on enterprise data warehouses and we believe that these types of non-traditional data warehousing use cases represent an important element of growth in our market and that we are well positioned to benefit from this shift, since performance, time to value and ease of use are key characteristics of the infrastructure that will enable these applications to be created and deployed.

Pat, over to you for the details of our performance in the quarter.

Patrick J. Scannell, Jr.

Thanks, Jim. I am very pleased with the results of our quarter and the traction that we are getting in the marketplace. Our FY08 Q2 performance exceeded all of our financial plans and has set the stage for a strong foundation to move forward as we continue to deliver improvements on our operating model.

We saw accelerating activity, both in our installed based and in new accounts, and across all of our vertical markets. We continue to invest in all of the initiatives in R&D and in the build-out of our sales distribution channels. We are making progress on achieving the goals we set out in improvements to our operating model as we march toward profitability on a GAAP basis.

We have determined that the stock-based compensation is a part of the cost of doing business, and have accordingly isolated all of our disclosure to GAAP-based disclosure. However, we have called out the stock compensation amounts included in the P&L for those that want to assess the non-GAAP performance of the company.

Turning now to revenue, revenue for the second quarter was $28.4 million, representing an increase of 60% over the second quarter last year of $17.8 million, and a sequential increase of 12% from the last quarter. Revenue for the first half of the year was $53.7 million, or an increase of 80% over $29.8 million for the first half of last year. The distribution of the revenue over the three months of the quarter was 25%, 10%, 65%.

Our vertical market distribution was 31% in financial services, 24% in the government, 23% e-business, 8% telecom, and 8% retail, with the remaining 6% split between our analytical service providers and healthcare, which gives ongoing evidence that our technology continues to be deployed successfully across a wide variety of vertical industries.

For the same period a year ago, this distribution was 26% e-business, 26% analytical service providers, 20% retail, 9% government, 7% financial services, and 6% telecommunications, with the remaining 6% split between healthcare and other markets.

Geographically, 73% of our business was generated in the U.S., 27% internationally. The international sector was split 24% in Europe and 76% in Asia-Pac. We landed a large federal contract in a foreign jurisdiction with an intelligence application which we believe had significant potential for more activity over the next 12 to 18 months, not only in this geography but with allied countries with similar needs throughout the world.

Today, we operate in seven countries and have 28 personnel deployed, with a number of reselling and distribution partners internationally. As Jim mentioned, we are deploying resources in Germany and in Southeast Asia, as well as continuing our campaign to recruit reseller and distribution partners in other geographies throughout the world.

Today, we have 35 quota carrying teams in addition to the resellers and analytical service providers, and will continue to invest in both of these initiatives as our business accelerates.

Fifteen-percent of our Q2 revenue was from our indirect channel. This is compared to 18% a year ago.

We successfully closed eight new accounts this quarter, accounting for 53% of this quarter’s revenue, bringing our total customer count to 109. Our installed base continues to be one of our strongest assets in promoting our technology within their own organizations for new applications and expansion with existing applications and in being 100% referenceable for our future prospects.

We had three customers this quarter that each accounted for more than 10% of the revenue for the quarter. However, no one of these customers will represent more than 10% of our fiscal year revenue.

Product and service revenue continued to be split at roughly the 80-20 mix, 80% product, 20% service. This mix may shift from time to time from 80-20 to 75-25, or even 85-15 depending on the product revenue volumes.

Our service revenue increases ratably with the increase in our installed base, where today almost all of our customers are on service contracts, giving them 7-by-24 appliance support as well as software updates.

Service revenue this quarter was $5.5 million, up from $3.4 million a year ago, or an increase of 61% and a sequential increase of 15% from last quarter.

Turning now to margins, we delivered a blended gross margin of 60%, combining our product margins of 59% with our service gross margins of 64%. This is consistent with what was reported a year ago with 58% product margin and 67% service margins. You can expect that these margins will continue to blend in at the 60% level as we continue to grow our business.

Margins are impacted by a number of factors, including maintaining inventory at the lower cost of market, discounting in certain international marketplaces where we are relying on resellers, and in the level of investment that we make in our support resources.

Having gone through three generations of technology, all of our inventory that is on the balance sheet is fairly valued, fresh, and saleable as new. Further, we are extremely careful to ensure that we invest adequately in our support personnel, as we want to ensure that we are not outstripping our ability to service our installed base of customers. This is a fundamental tenant of our value prop that allows us to maintain our customer relationships and have them come back time and time again with additional purchases of our technology.

Turning to operating expenses, we had operating expenses of $17.4 million, which was up from $12.8 million a year ago, or an increase of 36%. The company closed Q2 operating with 243 personnel, which was up from 207 a year ago. We will continue to invest in all functions, with an emphasis on sales, support and R&D, while ensuring that we are maintaining the proper level of infrastructure, systems and controls to support a multi $100 million operation.

Our Q2 FY08 op-ex included $936,000 of stock-based compensation expense, compared with $147,000 a year ago. As I said earlier, this is a cost of doing business and it’s included in our financial statements as a cost of doing business. However, we have broken it out here and on the face of the published P&L for those that want to assess the non-GAAP performance of the company.

Turning to our operating loss, the operating loss for the company in Q2 was $476,000 versus a loss of $2.2 million a year ago, or a decrease of 78%, and the year-to-date operating loss of $2.1 million versus $6.5 million year-to-date operating loss a year ago, or a decrease of 68%.

The net loss for the company in Q2 FY08 was $2.4 million, versus a net loss of $3.4 million a year ago. This includes $1.4 million in preferred stock accretion, which is a non-cash, pre-IPO charge, along with a stock comp of $936,000 noted previously, versus a $1.5 million accretion charge and $147,000 in stock comp a year ago.

The net loss for the company in year-to-date FY08 was $5.8 million versus a net loss of $9 million for the same period a year ago. This includes $2.9 million in preferred stock accretion charges, along with the stock comp of $1.8 million versus $3 million in accretion charges and $217,000 in stock comp for the same period a year ago.

Now that we are public and all our preferred stock has been converted to common stock, this preferred stock charge is no longer relevant.

Q2 EPS was a loss of $0.19 a share versus a loss of $0.46 a share a year ago, and year-to-date EPS was a loss of $0.55 in FY08 versus $1.24 a year ago.

I am going to spend some time taking you through the shares so that there is no confusion there and you can understand our methodology. So the shares used in calculating EPS were derived as follows: there were 57.4 million total shares outstanding at July 31, 2007. The 38.8 million shares of preferred stock that converted to common at the IPO and the 10.4 million newly issued shares at the IPO were both weighted for the eight days that they were outstanding in the quarter. This 9% weighting on the majority of the total shares outstanding at the end of the quarter dropped the shares used in calculating EPS down to the 12.4 million shares for the quarter.

Turning to the balance sheet, we exited Q2 with over $116 million in cash and cash equivalents. We received proceeds from our July IPO of over $113 million, net of offering expenses, and we extinguished all of our outstanding debt of $13.7 million.

We generated $3.9 million of cash from operations for the quarter. Today, our cash is invested with three major institutions that are managing this in accordance with the company’s investment policy. Our expectation is that these proceeds may be used to acquire technology and/or distribution partners, with some combination of cash and equity. However, there are no imminent candidates or prospects for this activity at the present time.

Accounts receivable ended the quarter at $18.9 million, with DSOs of 60 days. Our target DSOs remain at 75 to 85 days, even though we had the benefit of some early payment from some customers this quarter. We ended the quarter with $33.2 million in inventory, $16.5 million was finished goods inventory ready for customer shipment and $13.4 million was our proof-of-concept inventory deployed at customer sites and in our offices.

As I indicated earlier, all of this inventory is current and saleable as we constantly rotate systems through to ensure that we are maintaining our inventory up to current revs and specs.

You can expect that our inventory turn rate will fluctuate between three and four times.

We ended the quarter with $37.4 million of deferred revenue. Approximately $29 million of that is made up of deferred maintenance revenue for our prepaid maintenance and support contracts, and the balance is deferred product revenue where we have a further obligation associated with future product deliverables.

Turning now to guidance, as we have indicated to the market, our intention is to give annual guidance with quarterly updates, with the exception of these next two quarters, where we will give you quarterly guidance on certain line items of the P&L. This is in an effort of letting you get to know us as we are a newly minted company, and us getting to know you.

Given our performance, traction, pipeline and execution to date, we feel comfortable guiding you to annual revenue numbers this year in the range of $114 million to $116 million, with sequential growth quarter over quarter.

The rate of investment will continue as previously planned. However, you will see continued operating income improvement from the levels shared with you today.

A caveat that I need to mention is that with respect to stock-based compensation expense that has been factored into our expense projections, our estimate of this expense is based upon estimates of Netezza's future stock price and volatility. To the extent that these vary from our estimates, stock compensation expense may increase or decrease beyond projections included in our expenses. Specifically, we expect stock compensation for Q3 and Q4 to be in the range of $1.3 million to $1.7 million per quarter.

Now I am going to take you through specific stock forecasts, which would be used in our EPS calculations as follows, and I’m going to deliver to you Q3 basic and diluted for the quarter, year-to-date, Q4 basic and diluted quarter and year-to-date: Q3 quarter basic, 57.6 million; Q3 quarter diluted, 64.2 million; Q3 year basic, 26.5 million; Q3 year diluted, 33.1 million; Q4 quarter basic, 57.9 million; Q4 quarter diluted, 64.5 million; Q4 year basic, 34.5 million; Q4 year diluted, 41.1 million.

That takes care of the detailed deep dive on the financials and I thank you for your attention. I would like to turn it back over to Jit for some closing remarks before we open it up for questions and answers.

Jitendra Saxena

Thanks, Pat. I would like to take this opportunity to make an additional point. On July 19th, we launched our IPO on NYSE. This was an important milestone for the company and this milestone would not have been possible without the passionate support of our customers and all the hard work of our employees. We want to convey our sense of gratitude to all of our customers, partners and employees.

We would now like to take your questions. Operator, would you please give the instructions?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Robert Semple with Credit Suisse. Please proceed.