NetScout Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended September 30, 2018. Dollar amounts below are in millions unless otherwise stated. The company provides network performance, service assurance, and security solutions to service-provider and enterprise customers.
Financial performance
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Revenue | $223.8 | $256.9 | $428.9 | $482.6 |
| Gross profit | $159.8 | $182.6 | $302.9 | $341.8 |
| Gross margin | 71% | 71% | 71% | 71% |
| Operating income (loss) | $(23.1) | $(1.2) | $(100.2) | $(34.8) |
| Net income (loss) | $(26.4) | $(2.5) | $(88.9) | $(26.7) |
| Diluted loss per share | $(0.34) | $(0.03) | $(1.12) | $(0.30) |
- Quarterly revenue fell 13% year over year; product revenue declined 23% to $110.8 million, while service revenue declined 1% to $113.0 million. Management attributed weakness mainly to lower service-provider spending on service-assurance and DDoS solutions.
- For the six-month period, revenue fell 11%; product revenue decreased 17% and service revenue decreased 4%. U.S. revenue declined 10%, and international revenue declined 13%.
- Quarterly operating and net losses widened. Six-month net loss increased by $62.2 million, driven chiefly by a $35.9 million intangible-asset impairment and a $9.2 million loss on the HNT tools divestiture. Higher interest expense also weighed on results.
- Operating cash flow was $32.7 million for the six months, versus $72.1 million a year earlier. Capital expenditures were $12.2 million. Cash and cash equivalents were $332.2 million; short-term marketable securities were $119.9 million.
- Long-term debt was $600.0 million, with $1.0 billion available under the revolving facility subject to its terms. The company reported compliance with debt covenants. Cash, cash equivalents and marketable securities totaled $452.1 million, compared with debt of $600.0 million.
- At September 30, current assets were $719.8 million and current liabilities were $339.0 million. Deferred revenue and customer deposits totaled $307.2 million.
Material changes, outlook and notable items
- Revenue accounting: NetScout adopted Topic 606 on April 1, 2018 using the modified retrospective method; comparative periods were not restated. Adoption increased reported Q2 revenue by $7.8 million and reduced reported net loss by $6.5 million versus the amounts that would have been reported under the previous standard. For the six months, it increased revenue by $9.6 million and reduced net loss by $6.7 million. Adoption increased opening retained earnings by $34.1 million.
- HNT tools divestiture: Completed September 14 for $1.3 million cash plus potential earnouts of up to $4.0 million. NetScout recorded a $9.2 million loss, including transaction and employee incentive costs, and a $35.9 million impairment charge earlier in the six-month period. A transition-services agreement may run for up to 18 months.
- Restructuring: The voluntary separation program generated $2.3 million of charges for 23 employees during the six months. NetScout anticipated approximately $16.1 million of additional charges for up to approximately 141 employees over the following six months.
- Management outlook: The company expects challenging market conditions—including service-provider spending pressure, longer sales cycles, order delays, and enterprise uncertainty over digital-transformation projects—to persist. It expects service revenue to continue declining, partly due to Topic 606 and lower professional-services revenue. It expects FY2019 operating cash flow to be lower than FY2018 because of working-capital changes, but believes available liquidity and expected operating cash flows will meet needs for at least 12 months. The filing provides no specific revenue or earnings guidance.
- Legal contingency: In September 2018, the court entered judgment in the Packet Intelligence patent case, enhancing the jury verdict by $2.8 million; the jury had awarded $5.75 million. The judgment also includes interest and running royalties through patent expirations, the last in June 2022. NetScout is pursuing post-judgment motions and says the loss is reasonably possible, estimating a range from $0 to the jury-awarded amount plus possible interest and costs.
- Other considerations: Verizon represented more than 10% of accounts receivable at quarter-end, though no customer exceeded 10% of revenue. Tax accounting under the 2017 Tax Act, including GILTI, remained under assessment. Management said disclosure controls were effective and reported no material changes to internal control over financial reporting other than implementation work for Topic 606 and the divestiture.
Key facts for investors to verify
- How much of the revenue decline reflects underlying demand versus Topic 606 timing effects, and whether service-provider spending improves.
- Progress against the restructuring plan and the expected additional charges and cash payments.
- Debt-service costs, covenant headroom, and the impact of floating interest rates on the $600 million outstanding balance.
- Developments in the Packet Intelligence litigation, including the final judgment, appeal, royalties, interest, and potential costs.
- Future performance of deferred revenue and the timing of its recognition; the company expected to recognize $230.1 million within 12 months.
- Final tax-accounting effects of the Tax Act and GILTI, and realization of HNT contingent earnout consideration.