NetScout Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended September 30, 2017 (quarter ended September 30, 2017). All figures below are in U.S. dollars; financial statement amounts are converted from thousands to millions where indicated.
Business context and results
NetScout provides network performance analytics, service assurance and cybersecurity products and services. It reports one operating segment. Management attributed weaker revenue mainly to reduced spending by a large tier-one service provider that had contributed more than 10% of revenue in the prior-year periods.
| Metric | Quarter ended Sep. 30, 2017 | Prior-year quarter | Six months ended Sep. 30, 2017 | Prior-year six months |
|---|---|---|---|---|
| Revenue | $256.9 million (-6%) | $272.0 million | $482.6 million (-11%) | $541.0 million |
| Product revenue | $149.3 million (-12%) | $168.9 million | $264.1 million (-21%) | $333.5 million |
| Service revenue | $107.6 million (+4%) | $103.2 million | $218.5 million (+5%) | $207.5 million |
| Gross profit / margin | $182.6 million / 71% | $187.5 million / 69% | $341.8 million / 71% | $369.5 million / 68% |
| Operating income (loss) | ($1.2 million) | $0.8 million | ($34.8 million) | ($9.9 million) |
| Net income (loss) | ($2.5 million); ($0.03) per diluted share | ($1.3 million); ($0.01) per diluted share | ($26.7 million); ($0.30) per diluted share | ($10.3 million); ($0.11) per diluted share |
| Non-GAAP net income | $26.2 million; $0.29 per diluted share | $36.4 million; $0.39 per diluted share | $33.8 million; $0.37 per diluted share | $62.8 million; $0.67 per diluted share |
Product mix and lower costs helped lift gross margin despite lower revenue. Service growth was driven by maintenance contracts. International revenue rose 12% in the quarter but declined 1% over six months; U.S. revenue fell 15% and 16%, respectively. Non-GAAP measures exclude specified acquisition, amortization, stock compensation, restructuring and other items and are not substitutes for GAAP results.
Cash flow, liquidity and debt
- For the six months, operating cash flow was $72.1 million, compared with $52.2 million a year earlier. Investing activities provided $82.0 million, largely reflecting maturities of marketable securities; financing activities used $211.7 million, including $200.0 million of share repurchases.
- At September 30, cash and cash equivalents were $251.5 million and marketable securities were $61.9 million, totaling $313.4 million. This was down $151.3 million from March 31, mainly because of repurchases, partly offset by operating cash flow.
- Long-term debt was $300 million under an $800 million senior secured revolving facility due July 2020. The reported interest rate was 2.74%; the company said it complied with its covenants at quarter-end.
- Management said available cash, debt capacity, short-term investments and expected operating cash flows should meet anticipated working-capital and capital-expenditure needs for at least 12 months.
Material changes, outlook and risks
- Revenue pressure from the large service-provider customer continued. Management expects future revenue mix to be more balanced between service providers and enterprise customers, with moderation at certain large providers and anticipated enterprise growth; timing of large projects may cause quarterly variation.
- Management expects service revenue to grow with the installed base and maintenance contracts, moderated by pricing erosion on renewals. It also expects operating cash flow to increase with anticipated higher revenue and collections, partly offset by cash operating expenses.
- NetScout acquired Efflux in July 2017 for estimated consideration of $8.6 million, including $0.5 million in escrow; the technology was integrated into Arbor Networks’ security offering.
- On October 24, 2017, the board approved a new repurchase authorization for up to 25 million shares, effective after completion of the existing 20 million-share program. Repurchases may be funded from cash, future free cash flow or debt; the company is not obligated to buy a specified amount.
- In October 2017, a jury found for Packet Intelligence in a patent case and awarded $5.75 million in damages, described as a running royalty. Final judgment had not been entered, post-trial motions remained available, and NetScout characterized the risk of loss as neither remote nor probable.
- Topic 606 is scheduled to take effect for the company April 1, 2018. Management expected a reduction in deferred revenue at adoption and a greater proportion of product revenue recognized upon delivery; the impact was still under evaluation. Management did not expect a material cash-flow impact.
- Other risks include large-project timing, service-provider spending, renewal pricing, foreign-exchange exposure and secured-credit-facility covenants. Management reported no material changes to the risk factors in its latest Form 10-K.
Important facts for investors to verify
- Whether product revenue and U.S. demand stabilize, and whether enterprise growth offsets continued moderation by major service providers.
- Whether reported gross-margin improvement persists as sales mix changes, and how GAAP losses compare with adjusted profitability.
- Cash generation after working-capital movements and ongoing repurchases; the filing does not provide a specific free-cash-flow forecast.
- Progress and final outcome of the Packet Intelligence case, including any final judgment, post-trial rulings or change in loss assessment.
- The amount and timing of future repurchases under the new authorization, and their effect on cash, debt and shares outstanding.
- The eventual balance-sheet and revenue-recognition effects of adopting Topic 606.