NetScout Systems, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended September 30, 2013 (fiscal Q2 and first half of fiscal 2014). Unaudited consolidated results; comparisons are with the corresponding 2012 periods.
Business context and results
NetScout provides network and application performance monitoring and service-delivery solutions. It reports one operating segment. Management highlighted the nGeniusONE platform, launched in the first quarter of fiscal 2014, which combines application and network performance management.
Key financial metrics
| Metric | Three months 2013 | Three months 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $92.1m | $84.5m | $173.9m | $160.9m |
| Gross profit / margin | $72.4m / 79% | $67.6m / 80% | $137.3m / 79% | $127.1m / 79% |
| Operating income | $15.9m | $16.9m | $24.8m | $25.1m |
| Net income | $9.9m | $9.9m | $15.1m | $14.9m |
| Diluted EPS | $0.24 | $0.23 | $0.36 | $0.35 |
- Quarterly product revenue grew 13% to $52.4m; service revenue grew 4% to $39.7m. For the six months, product revenue rose 10% and service revenue 5%.
- Quarterly gross profit increased 7%, while gross margin declined one percentage point. Six-month gross profit rose 8%, with margin unchanged. Product gross margin for the quarter was 77%; service gross margin was 80%.
- Operating expenses increased 11% in the quarter to $56.5m, led by sales and marketing, which rose 18%. Six-month operating expenses increased 10% to $112.5m.
- Six-month operating cash flow was $27.1m, versus $56.5m in the prior-year period. Investing activities used $16.8m and financing activities used $15.1m. Cash and cash equivalents decreased $5.0m during the six months.
- At September 30, cash, cash equivalents and marketable securities totaled $159.4m, up from $154.1m at March 31. Current assets were $223.1m and current liabilities $128.1m.
- No borrowings were outstanding under the $250m revolving credit facility; it matures in November 2016. The company reported compliance with its covenants.
Material changes versus prior periods
- Quarterly revenue growth was driven by product sales and international markets; international revenue rose 41% to $25.2m. Product units shipped increased 31%, partly offset by an 18% decline in average selling price, attributed to lower-priced packet-flow switch components.
- Quarterly operating income fell about 6%, despite higher revenue, as operating expenses rose; sales and marketing spending increased $4.8m. The prior-year quarter included $1.2m of restructuring charges, while none were recorded in the current quarter.
- First-half revenue grew 8%; general enterprise and government sales were growth contributors, while service-provider product revenue declined. One customer represented more than 10% of revenue for the six-month period.
- First-half operating cash flow fell $29.4m year over year. Management cited less favorable accounts-receivable cash flow, incentive compensation payments, higher inventory and payment timing. Days sales outstanding were 54, compared with 68 at March 31, 2013 and 30 at September 30, 2012.
- Share-based compensation expense increased to $6.7m for the first half from $4.8m. The company repurchased $16.3m of shares during the period, including $11.7m under its repurchase program.
Outlook, risks and unusual items
- Management expected continued revenue growth in fiscal 2014 and identified service providers as a significant potential growth driver. It expected single-digit service revenue growth and gross margin to remain relatively flat.
- Management expected fiscal 2014 operating cash flow to be in line with fiscal 2013 and capital expenditures to follow prior-year trends. It believed available liquidity and operating cash flows would cover working capital and capital expenditure needs for at least 12 months.
- Potential antitrust-law violations involving a former employee and third parties in fiscal 2012 sales to state agencies remained under investigation by the California Attorney General. NetScout said it was cooperating, had accrued an immaterial liability, and had been informed that the Department of Justice did not intend to act against the company; no charges or proceedings had been initiated against NetScout.
- Simena acquisition-related contingent liabilities were $4.1m for future consideration and $0.1m for contractual non-compliance at quarter end. Their fair values rely on management assumptions and probability-weighted estimates.
- Foreign-exchange exposure is managed with forward contracts; outstanding notional amount was $15.4m. The filing cites competition, product acceptance, international expansion, acquisition integration, and economic conditions among factors that could affect results.
- Management stated disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter. No material changes to the prior annual report’s risk factors were reported.
Important facts for investors to verify
- Whether product growth, particularly in enterprise and government markets, offsets continued weakness or variability in service-provider sales.
- Whether gross margins stabilize as product mix, lower selling prices and support costs evolve.
- Whether operating cash flow recovers from the first-half decline and whether receivables, inventory and deferred revenue trends normalize.
- How much of reported performance reflects acquisitions, acquisition-related amortization and share-based compensation; assess GAAP results alongside the company’s non-GAAP measures.
- Updates on the California Attorney General investigation and settlement or payment assumptions for Simena-related contingent liabilities.