NetScout Systems, Inc. — Form 10-Q Summary
Reporting period: Three months ended June 30, 2011, the first quarter of fiscal 2012. Amounts below are in U.S. dollars; financial statement amounts are in millions unless otherwise indicated. The statements are unaudited.
Business context and financial performance
NetScout provides hardware and software for service delivery management, service assurance and application performance management. It reports one operating segment. On April 1, 2011, it acquired Psytechnics, a voice and video monitoring software provider, for approximately $17.0 million in cash.
| Metric | Q1 FY2012 | Q1 FY2011 | Change |
|---|---|---|---|
| Revenue | $63.3 | $66.8 | Down 5% |
| Product revenue | $29.5 | $34.0 | Down 13% |
| Service revenue | $33.8 | $32.8 | Up 3% |
| Gross profit / gross margin | $49.4 / 78% | $52.2 / 78% | Gross profit down 5% |
| Operating income / operating margin | $4.3 / 6.8% | $11.6 / 17.3% | Operating income down 63% |
| Net income / diluted EPS | $2.4 / $0.06 | $7.1 / $0.17 | Net income down 66% |
| Operating cash flow | $6.3 | $23.9 | Down $17.5 |
Operating expenses increased 11% to $45.1 million. Research and development rose 16% to $11.3 million, sales and marketing rose 7% to $26.8 million, and general and administrative rose 23% to $6.5 million. Management attributed expense growth partly to Psytechnics, higher employee-related costs and increased share-based compensation.
Cash, debt and liquidity
- At June 30, 2011, cash and cash equivalents were $39.5 million, short-term marketable securities $142.3 million and long-term marketable securities $27.4 million; combined cash and securities totaled $209.2 million, down from $228.5 million at March 31, 2011.
- Operating activities provided $6.3 million; investing activities used $29.0 million, including $16.9 million for Psytechnics net of acquired cash; financing activities used $5.0 million, including $3.8 million of debt repayment.
- Total term-loan debt was $64.4 million, including $15.0 million current and $49.4 million long-term. The $10 million revolving facility was undrawn. The term-loan rate was 2.50%; the company reported compliance with its debt covenants.
- Management said available liquidity and expected operating cash flows should cover anticipated needs for at least 12 months. However, $17.2 million of auction-rate securities remained illiquid, valued using a discounted cash-flow model; failed auctions had persisted since 2008. The company reported a $2.3 million cumulative temporary valuation decline and said it intended and was able to hold the securities.
Material changes and management commentary
- Management cited few U.S. government bookings amid budget holds and weaker bookings from financial-services customers facing capital-spending pressure. These were partly offset by service-provider bookings up 33% and strong bookings from non-financial enterprises.
- Product revenue fell as enterprise revenue declined, including lower U.S. government and financial-services business. Product units shipped fell 18% and average selling price per unit fell about 7%, partly reflecting a mix shift to lower-priced products. International revenue rose 24%, while U.S. revenue fell 13%.
- Service revenue benefited from maintenance-contract growth, partly offset by lower training and other service revenue. The prior-year quarter included $1.4 million from expired, non-refundable contracts after the company determined it had fulfilled its obligations; management said future recognition from such contracts had not been significant.
- Management attributed lower net income to reduced gross profit, higher operating expenses, increased share-based compensation and Psytechnics-related costs. GAAP net income was $2.4 million; company-reported non-GAAP net income was $5.5 million and non-GAAP diluted EPS was $0.13. These non-GAAP measures exclude specified items and are not substitutes for GAAP results.
Outlook, risks and unusual items
- The filing provides no specific revenue or earnings guidance. Management expects international sales to remain a significant portion of revenue and stated that current liquidity should support its business plan and anticipated needs for at least 12 months.
- Key stated risks include demand weakness, particularly in government and financial services; competition and product-market acceptance; acquisition integration; foreign-exchange exposure; and the illiquidity and valuation uncertainty of auction-rate securities. The company uses foreign-currency forward contracts for hedging, not speculation.
- The Psytechnics acquisition added $13.2 million of goodwill and $4.35 million of identifiable intangible assets. The company recorded a $3.2 million valuation allowance against acquired deferred tax assets, primarily related to U.K. tax attributes, and said it would continue evaluating realizability.
- The estimated annual effective tax rate for fiscal 2012 was 34.5%. Management cited discrete tax items related to acquisition transaction costs and a return-to-provision adjustment, partly offset by forecast research and development credits.
- Management said ordinary-course legal proceedings were not expected to have a significant adverse effect. The filing reported no material changes to the risk factors in the prior Form 10-K. Disclosure controls were assessed as effective, with no material control changes reported during the quarter.
Important facts for investors to verify
- Whether government and financial-services demand recovers, and whether service-provider growth continues to offset weakness elsewhere.
- Whether operating expenses and share-based compensation growth moderate, and how Psytechnics performs and integrates.
- Cash conversion and working-capital trends, especially the decreases in deferred revenue and accrued compensation during the quarter.
- The valuation, redemption prospects and liquidity of the $17.2 million auction-rate securities position, including any future impairment assessment.
- Debt repayment schedule, covenant compliance and the assumptions underlying management’s 12-month liquidity assessment.