NetScout Systems, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended September 30, 2021 (fiscal 2022 second quarter). Unless noted otherwise, financial amounts are in U.S. dollars.
Business context and reporting period
NetScout provides service assurance and cybersecurity solutions to service providers and enterprises. It reports one operating segment. Management cited cloud migration, cybersecurity, analytics, and 5G as business trends, while noting that customer purchasing cycles and economic conditions remain uncertain amid COVID-19.
Key financial results
| Metric | Three months ended September 30, 2021 | Six months ended September 30, 2021 | Prior comparable period |
|---|---|---|---|
| Revenue | $211.9 million, up 3% | $402.2 million, up 3% | $205.3 million and $389.2 million |
| Product revenue | $101.6 million, up 10% | $183.6 million, up 12% | $92.0 million and $163.7 million |
| Service revenue | $110.3 million, down 3% | $218.6 million, down 3% | $113.4 million and $225.5 million |
| Gross profit / margin | $160.3 million / 76% | $296.1 million / 74% | $146.4 million / 71%; $277.3 million / 71% |
| Operating income (loss) | $12.2 million | $1.5 million | $3.8 million; loss of $10.7 million |
| Net income (loss) | $7.9 million; diluted EPS $0.11 | Loss of $3.4 million; diluted loss per share $0.05 | Loss of $3.7 million; loss per share $0.05; loss of $21.1 million; loss per share $0.29 |
| Operating cash flow | Not separately reported for the quarter | $47.3 million | $56.6 million |
For the quarter, product gross margin rose to 80% from 71%, while service gross margin was 72%, unchanged. For the six months, product gross margin was 76% versus 71%, and service gross margin was 71% versus 72%.
At September 30, cash and cash equivalents were $468.5 million and marketable securities were $7.3 million. Long-term debt was $350.0 million; cash and marketable securities therefore exceeded reported debt by approximately $125.8 million. Current assets were $701.6 million and current liabilities $370.8 million. Six-month capital expenditures were $4.3 million.
Material changes versus prior periods
- Revenue growth came from network performance management products for enterprise and service provider customers; lower DDoS product sales partly offset growth. Service revenue fell, primarily due to non-renewals associated with service-provider consolidation, discontinued products, and renewal timing.
- Six-month gross margin increased three percentage points. Management attributed improved results in part to lower model-calibration product delivery costs and lower intangible amortization; product obsolescence charges increased.
- Six-month net loss narrowed by $17.7 million. The quarter moved to net income from a year-earlier loss, while the six-month period remained loss-making.
- Sales and marketing expense increased 10% for the six months, including higher employee-related costs, events, advertising, commissions, and travel. Research and development expense declined 5%.
- Operating cash flow fell $9.3 million year over year to $47.3 million, partly due to changes in accrued compensation and other expenses and accounts receivable. Deferred revenue also declined as a source of cash.
Liquidity, debt, outlook, and risks
- In July 2021, NetScout refinanced its revolving facility: the commitment was reduced from $1.0 billion to $800 million and extended to July 2026. The company borrowed $350 million under the new facility to repay the same amount under the prior agreement. It reported $450 million of incremental borrowing availability and compliance with the leverage covenant at quarter-end. The debt carried a 1.34% interest rate at September 30.
- Management expects cash, operating cash flow, marketable securities, and available facility borrowings to fund obligations, capital spending, debt service, and working capital for at least the next 12 months. It plans continued infrastructure capital spending during fiscal 2022. It provided no specific numerical revenue or earnings guidance in the supplied filing text.
- Backlog increased $55.9 million from March 31 to $83.8 million. Most related to customization and integration projects and radio-frequency propagation modeling; management expected most project revenue to be recognized during fiscal 2022. The company cautioned backlog may not predict future sales.
- The Packet Intelligence patent case remains a material contingency. The company says the post-suit damages risk remains probable; the original $3.5 million pre-suit award was vacated, while a $2.25 million post-suit award was affirmed. Interest and royalties may also be owed, and any enhancement is not reasonably estimable, though management said it is likely within $0 to $2.8 million. The PTAB invalidated the asserted patent claims in third-party proceedings, but the plaintiff opposed NetScout’s request for dismissal and sought review.
- COVID-19 effects remain uncertain, including potential impacts on customers, suppliers, operations, and the broader economy. NetScout had deferred $8.9 million of employer payroll taxes, with half due by December 2021 and half by December 2022.
- Verizon represented more than 10% of quarterly revenue and more than 10% of accounts receivable at quarter-end. Management reported no material changes to previously disclosed risk factors. Disclosure controls were deemed effective; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether product growth and higher product margins are sustainable, given lower service revenue and increased product obsolescence charges.
- Whether the $83.8 million backlog converts to revenue on the expected fiscal 2022 schedule, and how much depends on project milestones and customization.
- Current status and potential financial exposure in the Packet Intelligence case, including interest, royalties, enhancement, and outcomes of PTAB review and district-court proceedings.
- Facility covenant headroom, borrowing costs after leverage-based pricing applies, and continued compliance with debt covenants.
- Cash generation in subsequent quarters, especially given the year-over-year decline in operating cash flow, repurchases, and payroll-tax payment deadlines.
- Customer concentration and COVID-19, supply-chain, and purchasing-cycle developments that could affect demand or delivery.