NetScout Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal first quarter ended June 30, 2020; comparative period is the three months ended June 30, 2019. Financial statements are unaudited. Amounts below are in U.S. dollars.
Business context and results
NetScout provides service assurance and security solutions for service providers and enterprise customers. It reported one operating segment. Management said enterprise sales of network performance management and DDoS offerings were strong, partly offset by weaker service-provider revenue.
Key financial metrics
| Metric | Q1 FY2021 | Q1 FY2020 | Change |
|---|---|---|---|
| Revenue | $183.8 million | $186.0 million | Down 1% |
| Product revenue | $71.7 million | $75.7 million | Down 5% |
| Service revenue | $112.1 million | $110.3 million | Up 2% |
| Gross profit / margin | $130.8 million / 71% | $131.3 million / 71% | Gross profit down $0.4 million |
| Operating loss | $14.5 million | $24.4 million | Loss narrowed $10.0 million |
| Net loss | $17.4 million; $0.24 per diluted share | $29.3 million; $0.38 per diluted share | Loss narrowed $11.9 million |
| Operating cash flow | $44.9 million | $49.5 million | Down $4.6 million |
Product gross margin rose to 70% from 64%, while service gross margin fell to 72% from 75%. Management-defined non-GAAP measures showed operating income of $20.6 million and net income of $12.2 million, versus $12.1 million and $5.6 million, respectively, a year earlier. These measures exclude specified items, including acquired-intangible amortization and stock compensation; the 2020 net income reconciliation also adds back $2.8 million of legal judgment expense. They should not be treated as substitutes for GAAP results.
Balance sheet, debt, and liquidity
- Cash and cash equivalents were $403.3 million; marketable securities were $23.2 million. Combined cash and securities totaled $426.5 million, up $37.4 million from March 31, 2020.
- Long-term debt was $450.0 million, unchanged from March 31. Net debt relative to cash and marketable securities was approximately $23.5 million, excluding lease liabilities.
- Current assets were $630.8 million and current liabilities $357.5 million. Deferred revenue and customer deposits totaled $349.5 million, of which $249.4 million was expected to be recognized within 12 months.
- Cash from operations was $44.9 million. Investing activities provided $20.5 million, largely reflecting net proceeds from marketable securities; financing activities used $4.1 million.
- The company reported $304 million of additional borrowing availability under its $1.0 billion revolving credit facility, based on covenant levels at June 30, and said it was compliant with covenants.
Material changes and management commentary
- Operating expenses fell 7% to $145.3 million. Sales and marketing declined $14.1 million, mainly from lower event and travel spending amid COVID-19 restrictions and cost controls. These savings were partly offset by higher employee-related costs and legal expenses.
- Net loss improved mainly due to lower sales and marketing costs, reduced interest expense, lower intangible amortization, and fewer inventory-related charges. Higher variable incentive compensation and legal-related expenses partly offset those benefits.
- Revenue by geography was broadly flat in the U.S.; Europe rose 11% and Asia 9%, while rest-of-world revenue fell 20%, primarily due to prior-year service-provider order timing.
- COVID-19 had not materially adversely affected reported first-quarter results, but affected transaction timing and customer purchasing decisions. Management said the longer-term impact was uncertain and could be material.
Outlook, risks, and unusual items
- No specific revenue or earnings guidance was provided. Management expected available cash, operating cash flow, marketable securities, and revolver availability to fund obligations, capital spending, debt service, and working capital for at least 12 months. It planned continued capital investment and was limiting discretionary spending and hiring.
- The stock repurchase program was temporarily halted to preserve capital; authorization remained in effect. No program repurchases occurred in the quarter. Shares withheld for employee tax obligations are separate from program repurchases.
- On July 14, 2020, an appeals court vacated a $3.5 million pre-suit patent damages award, affirmed $2.25 million of post-suit damages, and remanded the case to consider a possible enhancement. NetScout considered the post-suit loss probable; any enhancement was not reasonably estimable, with a possible range of $0 to $2.8 million, in addition to interest and royalties on post-trial sales.
- A U.K. VAT matter could require the company to collect and remit approximately £16 million from current customers if HMRC requires separate settlement. The company said that outcome was reasonably possible, but had not recorded a payable for those VAT amounts; it had accrued penalties it considered probable and estimable.
- Goodwill was $1.72 billion. The company reported no impairment from its prior assessment, but economic uncertainty and COVID-19-related conditions remain relevant to future impairment evaluations.
Important facts for investors to verify
- Whether COVID-19 and customer purchasing delays affect subsequent-quarter orders, revenue, and cash generation.
- The outcome and ultimate cost of the patent litigation, including enhancement, interest, and ongoing royalties.
- Whether HMRC requires separate settlement of the approximately £16 million VAT amount and the eventual penalty assessment.
- Debt covenant headroom, revolver availability, floating-rate exposure, and the company’s ability to manage its $450 million debt balance.
- How sustainable the lower sales and marketing spending is, and whether service costs and employee-related compensation continue to rise.
- Future goodwill and intangible-asset impairment assessments, given the substantial goodwill balance and uncertain economic environment.