NetScout Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended September 30, 2012; comparisons are with the corresponding 2011 periods. Unless indicated otherwise, amounts are in U.S. dollars.
Business context and reporting period
NetScout provides hardware and software solutions and related services for network service delivery, assurance and application performance management. It reports one operating segment. During the quarter, it acquired certain assets, technology and employees of Accanto Systems for $15.0 million, adding telecommunications voice-service monitoring capabilities.
Financial performance and liquidity
| Metric | Three months ended Sept. 30, 2012 | Year-over-year change | Six months ended Sept. 30, 2012 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $84.5 million | +16% | $160.9 million | +18% |
| Gross profit / margin | $67.6 million / 80% | Margin +1 point | $127.1 million / 79% | Margin +1 point |
| Operating income | $16.9 million | +$5.4 million | $25.1 million | +$9.3 million |
| Net income | $9.9 million | +41% | $14.9 million | +58% |
| Diluted GAAP EPS | $0.23 | vs. $0.17 | $0.35 | vs. $0.22 |
- Quarterly product revenue rose 21% to $46.2 million; service revenue rose 11% to $38.4 million. For the six months, product revenue increased 28% to $86.4 million and service revenue increased 9% to $74.5 million.
- Quarterly product gross margin was 78% and service gross margin 83%; both improved by 2 percentage points. R&D expense increased 36% in the quarter, primarily reflecting increased headcount and employee-related costs. The quarter also included $1.2 million of restructuring charges.
- Operating cash flow was $56.5 million for the six months, versus $17.9 million in 2011. Management attributed much of the increase to faster receivables collections; days sales outstanding were 30 days, compared with 70 days at March 31, 2012.
- Cash, cash equivalents and marketable securities totaled $235.6 million at September 30, up from $213.5 million at March 31. Current assets were $286.3 million and current liabilities $120.0 million. Six-month investing cash flow was a net $1.2 million provided; financing cash flow was $14.6 million used.
- Debt was $62.0 million at September 30 under a $250 million revolving facility, bearing 1.50% interest at period end. The company reported compliance with its covenants. It repaid the full $62.0 million on October 29, 2012; no facility borrowings remained as of the filing date.
- Management reported non-GAAP diluted EPS of $0.34 for the quarter and $0.53 for the six months, versus $0.24 and $0.37, respectively, a company-defined measure that excludes specified acquisition, stock-compensation, amortization and restructuring items, among others.
Material changes and management commentary
- Management attributed product growth chiefly to service-provider demand. Product units shipped increased 3% in the quarter and 20% in the six-month period; average selling prices rose about 19% and 9%, respectively, primarily due to product mix.
- Six-month new-business bookings increased 15%. Service-provider bookings rose 70%, while financial-enterprise bookings rose 4%; government-enterprise bookings fell 38%, which management attributed to federal-government deferrals of long-term strategic initiatives. Management expects service providers to remain an important growth driver.
- Product backlog was $19.5 million at September 30, compared with $13.0 million at March 31. The company cautioned that customers generally may cancel unshipped orders, so backlog is not assured revenue.
- On October 31, 2012, after quarter-end, NetScout acquired ONPATH Technologies for $40.0 million; $8.2 million was designated for payments to ONPATH employees and directors under transaction bonus and retention arrangements.
- Management said available liquidity and expected operating cash flows should cover anticipated needs for at least 12 months. It expects operating cash flow to increase with collections associated with anticipated higher revenue, partly offset by higher cash operating expenses. The filing provides no specific full-year revenue or EPS guidance.
Risks, contingencies and unusual items
- One customer represented more than 10% of revenue in both the quarter and six-month period, and more than 10% of receivables at September 30. This represents customer-concentration risk.
- The California Attorney General was investigating potential state and federal antitrust-law violations involving a former employee and third parties in fiscal 2012 state-government sales. NetScout said it believed it did not benefit from the transactions, was cooperating, and had accrued an immaterial liability. The company reported that the Department of Justice did not intend to take action against it; no governmental charges or proceedings had been initiated.
- Simena acquisition-related contingent liabilities remained: $6.5 million of future consideration and $565,000 for contractual non-compliance liabilities at September 30. Their valuation depends in part on management assumptions.
- The estimated annual effective tax rate was 36.2%, versus 34.2% in the comparable prior-year estimate. Management cited acquisition-related items, expiration of the R&D tax credit and foreign tax-rate differences.
- Foreign-currency forward contracts had $8.7 million notional value at September 30 and were used to hedge forecast operating expenses, not for speculation. The filing also identifies floating-rate debt exposure and cash balances at financial institutions exceeding federally insured limits.
Important facts for investors to verify
- Whether service-provider demand and bookings growth continue, and whether the decline in government bookings persists.
- How much of reported revenue growth and cash-flow improvement is sustainable, given product mix, one large customer and the unusually favorable receivables-collection period.
- Integration, performance and purchase accounting for Accanto and ONPATH, including the ONPATH transaction’s final working-capital adjustments.
- Outcomes and any additional accruals related to the antitrust investigation and Simena contingent liabilities.
- Capital allocation after repayment of the revolving debt, including share repurchases, acquisitions and the remaining liquidity position.