For those who missed the Conference Call and prefer to read a transcript rather than listen to the replay, here are my notes. What a great Conference call!
Sleeper
Data Return (DRTN) Conference Call Highlights
February 2, 2000, 9:00am ET
Replay (through 02/09/00)
Telephone: 1-800-633-8284, passcode ``14154213'
Internet: webevents.broadcast.com
Quarter Highlights (Q3, FY 2000):
[Note: Not a word-for-word transcription, but the "essence" of the call.]
[Financial results are contained in quarterly report, which is available at biz.yahoo.com]
DRTN participants:
Sunny C. Vanderbeck, Chairman and CEO
Stuart A. Walker, CFO
Management's Presentation:
Business Model and Value Proposition: "DRTN provides advanced hosting services for applications based on the Microsoft platform. The fastest growing area of Web hosting is in "complex hosting" and within that market Microsoft (MSFT) is capturing the greatest share and at the fastest pace. Essentially, we are at the sweet spot of this robust market."
Web hosting expected to be an $8B market; application hosting expected to be a $22B market by 2003.
"With our technological expertise and high level of managed services, we see significant growth opportunities for our company."
DRTN capital expenditures are "success-based" [meaning that capital is deployed to purchase and install facilities and equipment necessary to service customer backlog]. Relationship with Compaq (CPQ) provides the hardware platform; relationship with Level 3 Communications (LVLT) allows leveraging its investments in bandwidth and data center infrastructure, rather than spending DRTN's own capital resources.
LVLT has built 27 U.S. data centers and 4 European data centers; over 20 more planned worldwide. [LVLT actually plans at least 38 more facilities worldwide, per its current quarterly report.]
Alliances with MSFT, CPQ and LVLT allow DRTN to focus on what it does best:
"Providing our clients, enterprise customers and sophisticated 'dot-com' companies with the most advanced, managed services--powered by scalable deployment architecture and high performance content delivery, in a secure computing environment."
"We did enjoy an enormously successful quarter in all areas. The rate at which companies are adopting the outsourced model has been far ahead of industry expectations. Total revenue for the quarter increased sequentially by 98%, and by 630% year-over-year. This is an exceptional rate of growth that will certainly be difficult to match going forward. Currently, we're comfortable projecting sequential growth in the 25 to 35% per quarter range. At this time, we are guiding revenue estimates up slightly based mostly on the success we've seen in this quarter. We believe that we will continue to revise estimates upward based on the operating results of Q4."
"All of this growth clearly came at a price": Gross margin decreased from 26 percent to 10 percent as DRTN invested heavily in infrastructure. Expects gross margin to increase over time as DRTN gains economies of scale and leverages infrastructure.
Clients/Computer Servers:
952 customers at 12/31/99, up 22% vs. 779 at 09/30/99
During Q3, added 173 new clients (vs. 130 new clients in Q2) , including Netpliance.com, Tenet Healthcare, Gamebay.com and 3Com.
Expanded relationships with existing clients Dash.com, PlanetOutdoors.com, Pier1 Imports, Trane Co. and many other customers.
Number of customers increased, size of customers increased dramatically.
Average revenue/non-shared hosting (dedicated and cluster service) customer now over $6k per month [$72k+ per year].
Several new customers in the range of $30-40k/mo [$360-480k/yr] went "live" during the quarter.
Most customers implement about 3 services.
83% of new customers purchased shared hosting while 17% purchased dedicated or clustered services.
468 revenue-generating servers in production at 12/31/99 vs. 321`at 09/30/99, up 147 or 46%. From Q1 to Q2, servers increased 32%.
Number of shared servers decreased from 73 at 09/30/99 to 66 at 12/31/99 based on optimization improvements.
Number of dedicated servers increased 64% to 402, up from 37% growth during Q2.
Employees:
Nearly doubled headcount for second consecutive quarter.
Employee population as of 12/31/99: 229
As marketplace continues to adopt outsourcing, DRTN will continue to manage the growth of its infrastructure.
Hired ahead of demand, now focused on training new employees, getting them accustomed to procedures and business culture. Critical factor to long term success because clients depend fully on depth of DRTN's knowledge and expertise to keep their businesses running smoothly and effectively.
Added 50 employees in Q3.
Hiring will slow moderately in Q4 while Q3 hires are trained.
Leadership in defining and managing the employee experience--allows turnover to be kept to a negligible level.
Most employee additions in technical services and systems implementation staff (provisioning, monitoring new applications for new customers).
Marketing and sales staff increased from 26 to 40 people during the Q.
Outside sales force (senior sales force with clear understanding of the business value and technical solution): 15
Inside sales force: 12
Several district level sales managers (carry a quota)
Sales districts up and running: 17
Other Achievements:
Opened 3 new data centers (NYC; Washington, DC; and London) during the Q to add to existing base in Dallas and SF; new data centers establish a local presence in these new markets. More importantly, new data centers enhance DRTN's clustered services offerings, allowing geographically disbursed clustering solutions in the 3 new regions. This capability is extremely important for larger, complex sites that have traffic from around the globe. Provides faster network performance and higher reliability for all users by routing information on a geographic basis.
Vast majority of services still provided from Dallas. Has capacity for 12k more servers.
Capacity from addition of other 4 data centers brings on line the ability to support another 3-4k servers.
Expects to bring additional data centers on line in Q4 (by March '00) and expects to see the impact of bringing to customers the benefits of data centers in many locations.
Expects to more well balance revenue from multiple data centers over time, but Dallas likely to continue to have highest concentration of revenue.
Product and Service Announcements:
Became first hosting company to standardize advanced hosting services on MSFT Win2k operating system. "Scalability issue is dead; customers can expect more than a 30% increase in the performance of their existing applications."
DRTN now has more than 550 customers [about half of total} running on Win2k. Win2k used as the platform for Netpliance's Super Bowl ad campaign.
First hosting company to offer clustered hosting services based on CPQ ProLiant 8500 8-way [8-Intel processor] server. Combined with DRTN's advanced clustering expertise, provides an even higher level of scalability, reliability and redundancy for clients.
In January, announced ServerGuard (sm) (family of managed solutions for securing high-traffic e-commerce sites and corporate extranets); industry first in providing clustered, scalable and reliable security services. Introduced Messaging Center (first clustered, high availability messaging solution for companies using MSFT Exchange. Well on track with plan to broaden range of products and services and lead industry in delivery of technological innovation.
(Above new services not rolled out until late in Q3.)
Expansion of Existing Relationship with MSFT:
Expanded existing relationship with MSFT as a DRTN customer and rolled out managed services, effective January, 2000.
Several MSFT Web properties involved, including WindowsUpdate.Microsoft.com [MSFT's download site] and MSNBC.com [joint venture between MSFT and GE/NBC].
Arrangement with MSFT result of an RFI process that MSFT went through looking to move from a co-located Web hosting model to a managed services model. Interesting as it represents maturing of market at large. MSFT a bellwether for the technology industry. If MSFT can understand the business justification for the managed services model, sends a clear signal to the rest of the technology industry.
Traditional hosting model is a bundle or aggregation of server hardware, data center facilities, network bandwidth, managed services and deployment assistance. In understanding DRTN's core values around managed services, MSFT has purchased specific services from DRTN.
Interesting development in the way DRTN delivers services for MSFT. MSFT has purchased specific value-added services from DRTN for specific properties.
For WindowsUpdate.Microsoft.com and MSNBC.com, on the East coast, DRTN managing sites in an AboveNet (Metromedia Fiber--MFNX) facility; on the West coast, managing them in an Exodus (EXDS) facility. (Does not detract in any way from the LVLT relationship, as it's a different service offering.) Excited by MSFT award and by MSFT's understanding that DRTN can deliver services in almost any data center.
Vanderbeck unable to discuss "other ongoing hosting engagements with MSFT."
"Further updates to come with (respect to) other [MSFT] properties."
"We have built a substantial team dedicated to managing the heavy growth we expect to see in the number of [MSFT] sites and the size of these sites for which DRTN provides services."
Most of the computer servers in the AboveNet and Exodus facilities are new servers. DRTN does all of the configuration of new servers.
Part of DRTN's value add for MSFT is the ability to deploy servers very rapidly, using its own proprietary software tools. DRTN performs configuration and installation of servers, as well as ongoing management.
Financial Results:
[Detailed information available in quarterly report, as indicated above.]
"An exceptional quarter for revenue growth, powered mainly by the acceptance of outsourcing and the effectiveness of our sales force."
Revenue breakdown:
Dedicated hosting revenue: Up 117% Q-to-Q to $1.8mm, representing 53% of quarterly revenue (vs. 48% of revenue in Q2); reflects continuing shift to large-scale, complex and dedicated solutions.
Avg. monthly revenue per dedicated hosting customer: $6,041 vs. $3,757 in Q2, an increase of 61%.
Majority of new client wins requires complex Web hosting services using dedicated and clustered server solutions.
Shared hosting (entry-level service) revenue: $652,000, or 19% of total revenues. Increased 26% Q-to-Q. Avg. recurring revenue/customer was $293 vs. $282 in prior Q, an 8% increase. Has added to service offerings and capacity for shared customers (at higher cost). Discontinued two smallest offerings and now has single, consistent, shared service offering. Expects avg. revenue per shared hosting customer to increase due to enhanced program.
Initial set-up and other one-time fees totaled $950k for the Q, accounted for 28% of total revenues. Near term, expects set-up fees to continue to climb as a percent of total revenues as recurring revenue base grows. Recent new SEC guidance related to recognition of up-front fees. Expects that some of current up-front fees recognized as revenue upon installation and acceptance by the customer will require amortization over the underlying term of the contract.
Dedicated hosting customers accounted for $975k of revenue growth for the Q.
Rapid pace of growth felt in gross margins due to build-out of infrastructure and increase in headcount to meet robust demand. Expects to see margins rebound over time and expand with economies of scale.
Selling and marketing expenses decreased to 53% of revenues from 61% in prior Q.
With growth of recurring revenue base, commissions/compensation paid for new accounts decreases as percentage of total revenues.
G&A decreased sequentially as a percentage of revenues from 71% to 61% in latest Q. Making investments in people and processes that assist DRTN in managing rapid growth.
Stock-based compensation increased from $158k to $1.2mm, or 36% of revenues in current Q. Largely the result of October IPO, as a number of senior managers and long term employees have vesting acceleration provisions as part of option grants. Accelerated vesting upon completion of IPO caused deferred compensation expense relative to options to accelerate as well.
EBITDA was negative $3mm vs. negative $1.7mm in prior Q.
Net loss for the quarter was $4mm, or $0.12/share, vs.$1.9mm, or $0.07/shr in previous quarter, and $306,000, or $0.02/share, in prior year.
Gross margins expected to be 15% in Q4 '00 and trending up to 25-30% later in FY '01.
Miscellaneous:
Sitesmith, Silicon Valley, CA, is only other outside managed hosting firm (3-4 people). Industry grew out of telecom business, so it's facilities-oriented. Systems integrators might offer such services, but are generally not in the business of managing mission-critical systems.
No relationship with Exodus other than in context of MSFT Web site managed hosting support. EXDS relationship is principally with MSFT.
LINUX solutions/issues: Only likely platform challenge to MSFT is Sun (SUNW) Solaris running on Sun Ultra Enterprise hardware platform; LINUX not an issue.
Issue of MSFT Windows NT/2000 scalability, performance and reliability: concern has started to wane from enterprise customers.
"We've learned a lot about focus. This will continue to be our theme for years to come. The more we focus, the higher the quality of service we can deliver and the faster we go as a company." Will spend effort in innovation. Products like ServerGuard: the ability to create new value and new intellectual property around meeting very specific needs: scalability, performance and reliability. Product efforts over next quarter will be to enhance current service offerings: adding new services to beginning and end of the process.
Can engage the customer earlier in the life cycle and help customer test applications in real world scenarios and in the lab under loads that represent billions of hits per day. Objective that things go as planned in the real world. Netpliance used a "Beta" version of this testing service in preparation for its Super Bowl advertising roll-out. Tremendously higher level of comfort when ads started to run that the application had been tested and would respond to heavy demand and heavy loads.
DRTN hosting service is modular. Implicit assumption that every customer is buying at a minimum a Web hosting service and a database hosting service (and often, firewall service such as ServerGuard).
ASP market:
DRTN's view tends to differ somewhat from the rest of the market and the popular/trade press.
DRTN's enterprise customers' priorities are hosted hosted extranets, hosted Intranets and MSFT Exchange Server.
Opportunity: the millions of seats deployed for MSFT Exchange Server represent a huge opportunity for the ASP market.
Evolution of market has been from standardized hosting service to AIP/ASP (application infrastructure provider/application service provider). DRTN view is that customers go through a mental process where they understand the value of outsourcing their public Web site; gain trust there, first.
Enterprise customer evolution is a function of trust: outsourced Web hosting, extranets, Intranets and MSFT Exchange Server (500+ seats per customer); emphasis is on Exchange Server vs. such things as financial applications.
We're really further out from widespread adoption of ASP implementation of traditional client-server applications such as financial services than many people are led to believe.
Major enterprise customer challenges:
" 'The Prairie Dog Effect': When mail stops, work stops."
--Sunny C. Vanderbeck
What applications are creating pain in IT shops today?: Web infrastructure, database infrastructure and mail/messaging (Exchange Server). This is DRTN's focus rather than general application deployment.
"Thanks, everyone, for joining us. We look forward to seeing you at the end of another great quarter in about 90 days."
Financial Analyst Q+A:
(Management responses integrated above.)
James H. Henry
Bear Stearns (lead underwriter)
"Your outperformance relative to our numbers is a little embarrassing..."
1) Expand on MSFT managed hosting relationship on contractual basis (significance of MSFT's moving from co-location model to managed services model).
2) Revenue per data center based on new openings (majority of revenue has been generated from Dallas).
[Following the release of quarterly results and the conference call, Bear Stearns "strongly reiterated" its "Buy" rating and raised DRTN's 18-month price target to $100/shr on 02/03/00].
Steve Murphy
CIBC World Markets
"Congratulations on a fantastic quarter."
1) What's the trend in increasing deal size?
2) Impact of new services during the quarter?
3) Breakout of employee additions?
4) Who are competitors offering managed hosting in outside data centers?
Jim Lennon (sp?)
Thomas Weisel Partners
"Nice job, guys."
1) Commercial relationship with Exodus (relative to European roll-out)?
2) How many different kinds of services are customers taking from DRTN? Has there been a Q-to-Q ramp in this regard?
3) What are you seeing in the marketplace relative to potential customers wanting to deploy a LINUX solution vs. MSFT?
Marlowe Burke (Ms.)
Wit Capital/SoundView
"Congratulations, great quarter."
1) Gross margin trends over next quarter and for the next year?
2) What areas are you looking at for new service offerings?
Matt Werndorf (sp?)
Legg Mason
[possible new research coverage of DRTN]
"Nice quarter."
1) Re: ASP issues. Where is largest demand for applications?
2) What opportunities are you seeing for additional applications from MSFT or others? |
