NetScout Systems, Inc. — Q1 FY2016 Form 10-Q
Reporting period: Three months ended June 30, 2015; unaudited. Comparisons are with the three months ended June 30, 2014, unless noted. NetScout provides network, application and service assurance products and support services.
Financial performance
| Metric | Q1 FY2016 | Prior year | Change |
|---|---|---|---|
| Revenue | $100.7 million | $107.9 million | Down 7% |
| Product revenue | $53.6 million | $64.4 million | Down 17% |
| Service revenue | $47.2 million | $43.5 million | Up 8% |
| Gross profit / margin | $79.4 million / 79% | $85.3 million / 79% | Gross profit down 7%; margin flat |
| Operating income | $12.4 million | $19.6 million | Down 37% |
| Net income | $7.7 million | $11.5 million | Down 33% |
| Diluted EPS | $0.19 | $0.27 | Down 30% |
| Operating cash flow | $9.3 million | $28.2 million | Down $18.9 million |
Operating margin was approximately 12.3%, versus 18.2% a year earlier. The effective tax rate declined to 37.4% from 41.1%, primarily due to interim accounting treatment of certain foreign losses. Non-GAAP net income was $13.7 million and non-GAAP diluted EPS was $0.33, compared with $15.2 million and $0.36, respectively; these measures exclude specified acquisition, amortization and share-based compensation items.
Liquidity, cash flow and debt
- Cash, cash equivalents and marketable securities totaled $267.5 million at June 30, up from $264.9 million at March 31, 2015. Cash and equivalents alone were $94.4 million.
- Operating cash flow was $9.3 million. Investing activities used $16.8 million, including $3.4 million for fixed assets; financing activities used $3.2 million, mainly for share repurchases. Cash and equivalents decreased $10.5 million during the quarter.
- There was no borrowing outstanding on the existing $250 million revolving facility at June 30. The quarter-end balance sheet showed no long-term debt.
- After quarter-end, NetScout entered into a five-year, $800 million senior secured revolving facility and drew $250 million. The filing says the draw supported working capital and helped finance share repurchases. The new facility carries leverage and interest-coverage covenants.
Material changes and management commentary
- Product revenue fell mainly because of lower service-provider sales, reflecting the timing and size of projects and unusually strong service-provider orders in the prior-year quarter. General enterprise product revenue partly offset the decline. Product units shipped fell 13% and average selling price fell 7%.
- Service revenue grew with the installed base and related maintenance contracts. Management expects continued service growth as product sales expand the installed base.
- Sales and marketing expense rose 2% and general and administrative expense rose 15%; management cited user-conference and sales-event costs and Danaher transaction-related business-development expenses. The filing reports $3.4 million of acquisition-related costs for the quarter.
- On July 14, 2015, after the reporting period, NetScout completed its acquisition of Danaher’s Communications Business through a Reverse Morris Trust transaction. Equity consideration was approximately $2.3 billion, including about 62.5 million newly issued NetScout shares. The preliminary allocation included $1.5 billion of goodwill. Acquired operations are included in results beginning on the closing date, not in this quarter’s results.
- Management said the transaction is expected to more than double the addressable market to over $8 billion. It anticipated service providers would represent about 60% of quarterly revenue, depending on project timing, and that roughly one-third of combined revenue would come from outside North America.
Outlook, risks and contingencies
- Management expected existing liquidity, available debt and operating cash flows to cover working capital and capital expenditure needs for at least 12 months. It expected operating cash flow to increase with anticipated higher collections and revenue, partly offset by higher cash operating expenses. No specific quarterly or full-year revenue or earnings guidance is provided.
- Management expected continuing capital expenditures to support infrastructure. It anticipated approximately $9.6 million of investment-banking fees for the transaction during FY2016; integration and synergy-related costs were not yet estimable.
- Key risks include difficulty realizing acquisition benefits or integrating operations, potential integration costs and management distraction, foreign-exchange exposure, and increased indebtedness and covenant restrictions. The company reported no material adverse effect from current legal proceedings in management’s assessment.
- The Simena acquisition contingent consideration liability was $4.5 million at June 30. The company had $65.7 million remaining under its existing repurchase authorization at quarter-end; a new authorization for up to 20 million shares became effective upon the acquisition closing.
Important facts for investors to verify
- How much of the revenue and earnings decline reflects service-provider project timing versus underlying demand, and whether service revenue growth continues.
- The final acquisition purchase-price allocation, integration costs, realized synergies and contribution from the acquired business.
- The use of the $250 million facility draw, subsequent debt levels, interest expense and compliance with credit-facility covenants.
- The pace and financing of repurchases under the new 20-million-share program, including dilution from the acquisition’s newly issued shares.
- Whether the expected cash-flow improvement and stated liquidity outlook are achieved as post-acquisition operating needs evolve.