NetScout Systems, Inc. — Form 10-Q Summary
Business context and reporting period
Quarter ended December 31, 2016 (fiscal 2017 third quarter); financial statements are unaudited. NetScout provides network performance, service assurance and cybersecurity solutions. It reports one operating segment following its reorganization effective July 1, 2016. Comparisons are affected by the July 2015 acquisition of Danaher’s Communications Business, which contributed a full nine months in the current period but only about five and a half months in the prior-year period.
Financial performance
| Metric | Three months ended Dec. 31, 2016 | Prior-year quarter | Nine months ended Dec. 31, 2016 | Prior-year period |
|---|---|---|---|---|
| Revenue | $302.2m | $307.7m | $843.2m | $669.5m |
| Gross profit / margin | $220.5m / 73% | $201.6m / 66% | $590.0m / 70% | $441.9m / 66% |
| Operating income (loss) | $33.4m | $2.3m | $23.4m | $(20.6)m |
| Net income (loss) | $21.2m | $(24.5)m | $11.0m | $(24.8)m |
| Diluted GAAP EPS | $0.23 | $(0.25) | $0.12 | $(0.32) |
| Non-GAAP diluted EPS | $0.60 | $0.58 | $1.27 | $1.47 |
Quarterly product revenue fell 8% to $192.0m, while service revenue rose 12% to $110.2m. Product weakness in service assurance across service-provider and enterprise markets more than offset cybersecurity growth. For the nine-month period, product revenue increased 20% and service revenue increased 37%, primarily reflecting the fuller contribution from the Communications Business acquisition.
Quarterly GAAP operating income improved as cost of revenue and operating expenses declined year over year, including lower acquisition-related and post-combination costs. Acquired-intangible amortization increased to $17.5m from $11.2m in the quarter and was $52.6m for the nine months. Non-GAAP measures exclude substantial acquisition, amortization, share-based compensation and other items; they should be considered alongside GAAP results.
Cash flow, debt and liquidity
- Operating cash flow was $131.9m for the nine months, versus $56.6m in the prior-year period. Capital expenditures were $21.7m.
- Cash, cash equivalents and marketable securities totaled $376.9m at December 31, 2016, up $24.8m from March 31, 2016. Cash and securities held in the U.S. were $287.7m; approximately $89.2m was held outside the U.S.
- Long-term debt was $300.0m under an $800m senior secured revolving facility maturing July 2020. The company reported covenant compliance; the debt bears floating interest, with a stated rate of 2.27% at December 31.
- Net cash used in financing was $89.2m, including $79.3m of share repurchases. Approximately 6.8m shares remained available under the repurchase authorization.
- Accounts receivable and unbilled costs were $284.1m; days sales outstanding were 83, compared with 80 at March 31, 2016 and 71 a year earlier.
Changes, outlook and risks
- Management described market conditions as challenging, particularly the timing and size of service-provider orders. Quarterly revenue declined 2%; U.S. revenue fell 12%, partly offset by 19% growth in international revenue.
- Management expects service-provider customers to remain a significant part of the revenue mix, but noted that project timing can shift quarterly results. Service revenue growth depends in part on product sales expanding the installed base and supporting maintenance contracts.
- Management stated that available liquidity and expected operating cash flows should meet working-capital and capital-expenditure needs for at least the next 12 months. It expects operating cash flow to increase with anticipated higher revenue collections, partly offset by cash operating expenses. No numerical revenue or earnings guidance was provided.
- The $4.6m Avvasi asset acquisition adds technology for measuring and improving video traffic over 4G/LTE networks. Restructuring charges were $1.7m for the nine months; the remaining restructuring liability was $0.2m.
- Goodwill was $1.72bn and net intangible assets were approximately $959m. In the July 2016 reporting-unit impairment assessment, Security’s estimated fair value did not substantially exceed its carrying value, although management’s stated sensitivity tests did not change its no-impairment conclusion.
- Contingencies include $4.8m of future consideration related to Simena and $0.66m held in escrow related to Avvasi. Management said ordinary-course legal proceedings were not expected to have a material adverse effect. The company reported no off-balance-sheet arrangements and no material changes to the risk factors in its latest Form 10-K.
- One direct customer represented more than 10% of revenue in both the current and comparable periods; no customer name or revenue share is specified in the filing text provided here.
Important facts for investors to verify
- Underlying demand and order timing in service-provider and enterprise markets, and whether cybersecurity growth can offset service-assurance weakness.
- How much reported revenue and cash-flow growth reflects acquisition-period differences, and whether organic performance supports management’s outlook.
- The quality of operating cash flow, including working-capital movements, receivables growth and the increase in days sales outstanding.
- The scale and duration of acquired-intangible amortization and other adjustments excluded from non-GAAP results.
- Security reporting-unit goodwill headroom, covenant capacity, floating-rate debt exposure, and the company’s continued repurchases while carrying $300m of debt.