NetScout Systems, Inc. — FY2017 Form 10-K
Reporting period: Fiscal year ended March 31, 2017. This is an annual report, not a standalone fourth-quarter filing; quarterly results are included in the filing. NetScout provides network performance analytics, service assurance and cybersecurity products to enterprise, service-provider and government customers. The Communications Business acquired from Danaher in July 2015 materially expanded the company.
Financial performance
| Metric | FY2017 | FY2016 |
|---|---|---|
| Revenue | $1,162.1 million | $955.4 million |
| Gross profit / gross margin | $816.0 million / 70% | $627.0 million / 66% |
| Operating income (loss) | $62.1 million | $(25.6) million |
| Net income (loss) | $33.3 million | $(28.4) million |
| Diluted GAAP EPS | $0.36 | $(0.35) |
| Cash from operating activities | $227.8 million | $95.3 million |
| Cash, cash equivalents and marketable securities | $464.7 million | $352.1 million |
| Debt | $300.0 million | $300.0 million |
| Working capital | $394.3 million | $283.4 million |
Product revenue was $735.5 million, up 16%; service revenue was $426.6 million, up 32%. International revenue grew to $432.7 million, or 37% of total revenue, from $273.9 million, or 29%. Operating margin was approximately 5.3% and net margin approximately 2.9%.
Management also reported non-GAAP operating income of $275.4 million versus $246.8 million, and non-GAAP diluted EPS of $1.92 versus $1.91. These company-defined measures exclude substantial items, including acquired-intangible amortization, share-based compensation and acquisition-related expenses; they should be considered alongside GAAP results, not as substitutes.
Changes and key drivers
- Reported revenue increased 22%, but FY2016 included only about eight and a half months of Communications Business results, compared with a full year in FY2017. Much of the reported increase therefore reflects acquisition timing rather than comparable organic growth.
- Management cited challenging selling conditions, chiefly affecting the timing and size of service-provider orders. In the legacy business, service-provider product revenue fell $14.1 million; legacy enterprise product revenue rose $10.8 million, while legacy maintenance revenue declined $2.8 million.
- Gross margin improved four percentage points to 70%. Product margin rose to 68% from 62%, and service margin to 75% from 72%.
- Operating income returned to positive territory. FY2017 included $70.1 million of acquired-intangible amortization and $4.0 million of restructuring charges. Restructuring charges were expected to include a further approximately $0.7 million in FY2018’s first quarter.
- Operating cash flow rose to $227.8 million. Cash and investments increased by $112.6 million, partly offset by $80.0 million of share repurchases, $29.7 million of capital expenditures and $4.6 million for the Avvasi acquisition.
Liquidity, debt and outlook
NetScout had $464.7 million in cash, cash equivalents and marketable securities, including approximately $102.1 million held outside the United States, against $300.0 million drawn on its $800 million secured revolving credit facility. The facility expires July 14, 2020; the reported interest rate on the outstanding debt was 2.49%. The company reported compliance with its debt covenants at year-end. Management expected available cash, borrowing capacity, securities and operating cash flows to cover working capital and capital expenditures for at least the next 12 months.
No numerical revenue or earnings guidance is provided in the supplied filing text. Management expected operating cash flow to increase, citing anticipated higher revenue and collections, partly offset by higher cash operating expenses. Planned FY2018 product work included public-cloud application monitoring and further integration of acquired capabilities. Backlog fell to $62.7 million from $125.7 million; management cautioned it is not a reliable indicator of future sales. A majority related to acquired customization and integration projects, with a majority of those projects’ revenue expected in FY2018.
Risks, contingencies and unusual items
- Integration and realization of benefits from the $2.3 billion Communications Business transaction remain important execution risks; acquired goodwill and intangible assets are substantial. The company reported no goodwill impairment in FY2017.
- Other principal risks include volatile customer order timing and lengthy sales cycles, competition and technology change, customer and service-provider spending, cybersecurity threats, foreign-exchange exposure, reliance on certain suppliers, and retaining skilled employees.
- Verizon accounted for more than 10% of revenue in both FY2017 and FY2016. No customer or channel partner exceeded 10% of accounts receivable at March 31, 2017.
- Contractual obligations included $324.9 million of long-term debt obligations, $39.7 million of operating leases, $32.2 million of purchase obligations and $30.1 million of pension benefit obligations. The filing states that ordinary-course legal claims were not expected by management to have a material adverse effect.
- The company expected adoption of the new revenue standard (Topic 606) on April 1, 2018 to reduce deferred revenue and accelerate recognition of a greater proportion of product revenue; the impact was still under evaluation, with no expected cash-flow effect.
Investor verification priorities
- Separate acquisition-related growth from comparable performance, particularly legacy service-provider demand and maintenance trends.
- Assess the quality and sustainability of improved operating cash flow, including working-capital movements and receivables; days sales outstanding was 80 days, unchanged from FY2016.
- Review the reconciliation and recurring nature of non-GAAP adjustments, especially acquired-intangible amortization, share compensation and integration costs.
- Monitor debt, interest-rate exposure, covenant headroom and the company’s plans for repurchases, acquisitions and cash held overseas.
- Track backlog conversion, integration milestones, restructuring costs and the financial impact of Topic 606 adoption.