NetScout Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended September 30, 2015. The quarter includes approximately two and one-half months of results from the Communications Business acquired from Danaher on July 14, 2015. Amounts below are U.S. dollars.
Business context and transaction
NetScout provides network service-assurance and cybersecurity solutions. The Danaher Communications Business acquisition added Tektronix Communications, Arbor Networks, VSS Monitoring and portions of Fluke Networks Enterprise. NetScout issued approximately 62.5 million shares, valued at $2.3 billion, in the transaction. Management said the deal is intended to expand the company’s addressable market, product range and global reach.
Financial performance and liquidity
- Quarter revenue: $261.1 million, up 152% from $103.6 million. Product revenue was $174.9 million and service revenue $86.2 million. The acquired business was the primary source of growth.
- Quarter profitability: Gross profit was $160.9 million; gross margin was 62%, down from 79%. Operating loss was $35.3 million and net loss was $7.9 million, versus prior-year operating income of $18.6 million and net income of $11.2 million. Diluted loss per share was $0.09.
- Six-month results: Revenue was $361.9 million, up 71%. Gross profit was $240.4 million and gross margin 66%, compared with 79% a year earlier. Operating loss was $22.9 million and net loss $0.2 million, versus prior-year operating income of $38.2 million and net income of $22.7 million.
- Non-GAAP results: Quarter non-GAAP net income was $43.6 million, or $0.47 per diluted share; six-month non-GAAP net income was $57.2 million, or $0.86 per share. These measures exclude substantial acquisition, amortization, share-based compensation and other adjustments; see the filing’s reconciliation.
- Cash flow: Six-month operating cash flow was $6.9 million, down from $29.0 million. Investing activities provided $42.7 million, including $27.7 million of acquired cash; financing activities provided $61.3 million, including debt proceeds and offset by share repurchases.
- Liquidity and debt: Cash, cash equivalents and marketable securities totaled $351.4 million at September 30, up from $264.9 million at March 31. Long-term debt was $250 million under a new $800 million senior secured revolving facility, due in 2020. The company reported covenant compliance. It spent $185.0 million on treasury-stock repurchases during the six months.
Material changes versus the prior period
- Reported revenue and operating scale increased significantly with the acquisition, but comparisons are not like-for-like because the acquired operations are included only from July 14, 2015.
- Quarter gross margin fell to 62% from 79%; operating expenses rose to $196.2 million from $63.4 million, including acquisition-related costs, expanded staffing and acquired-intangible amortization.
- The acquisition added $168.8 million of revenue and a $19.5 million net loss to the six-month results, according to the filing. The company recorded $17.9 million of acquisition-related costs for the six months.
- Shares outstanding increased substantially following issuance of acquisition shares. The company also repurchased 4.5 million shares under its new 20-million-share authorization through September 30.
Outlook, commentary and risks
- Management stated that available cash, marketable securities, credit availability and expected operating cash flows should cover working capital and capital expenditures for at least the next 12 months. It expects operating cash flow to increase with higher collections and revenue, partly offset by cash operating-cost growth.
- No specific revenue or earnings guidance was provided in the supplied filing text. Management expects continued investment in capital expenditures and anticipates that international markets will represent a significant share of revenue; it estimated roughly one-third of combined-company revenue would come from outside North America.
- Integration costs and potential synergies had not been estimated. Risks include execution and integration challenges, the possibility that anticipated acquisition benefits are delayed or not realized, potential asset write-downs, foreign-exchange exposure and debt covenants or floating-rate interest costs.
- Acquisition purchase accounting remained preliminary and could be adjusted during the measurement period, potentially materially. The transaction recorded approximately $1.5 billion of goodwill and $1.08 billion of acquired identifiable intangible assets.
- The company reported a $53.7 million receivable from Danaher, a concentration of credit risk. One direct customer represented more than 10% of quarterly and six-month revenue. Management said ordinary-course legal matters were not expected to have a significant adverse effect.
Important facts for investors to verify
- How much of revenue growth and future profitability comes from the acquired business versus legacy NetScout, using comparable pro forma results.
- Whether acquisition integration costs, purchase-accounting adjustments and expected synergies develop as management anticipates.
- Whether margins recover from the post-acquisition decline and how much acquired-intangible amortization affects GAAP earnings.
- Cash conversion and working-capital trends, including deferred revenue, the Danaher receivable and the concentration of revenue in a major customer.
- Share repurchases, dilution from acquisition-related share issuance, outstanding debt, interest costs and ongoing compliance with credit-facility covenants.
- The filing reports unusually high effective tax rates alongside losses; verify the tax effects and reconciliation of GAAP to non-GAAP results.