NetScout Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended September 30, 2011. Unless otherwise noted, amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions.
Business context and results
NetScout provides hardware and software for network service delivery management, service assurance and application performance monitoring. It reports one operating segment. The quarter’s results include Psytechnics, acquired April 1, 2011; Fox Replay was acquired October 3, 2011, after quarter-end.
- Management reported second-quarter new business and total bookings up 30% year over year. For the first half, new business bookings rose 9% and total bookings rose 16%.
- Second-quarter revenue growth was led by services and U.S. sales. First-half revenue was essentially flat, as lower product revenue offset service growth.
Financial metrics
| Metric | Three months ended September 30, 2011 | Three months ended September 30, 2010 | Six months ended September 30, 2011 | Six months ended September 30, 2010 |
|---|---|---|---|---|
| Revenue | $72.6m | $69.4m | $135.9m | $136.2m |
| Gross profit / margin | $57.0m / 79% | $55.1m / 79% | $106.4m / 78% | $107.3m / 79% |
| Operating income / margin | $11.5m / 16% | $13.3m / 19% | $15.8m / 12% | $24.9m / 18% |
| Net income / margin | $7.1m / 10% | $8.2m / 12% | $9.5m / 7% | $15.4m / 11% |
| Diluted EPS | $0.17 | $0.19 | $0.22 | $0.36 |
- Quarterly product revenue was $38.1m, up 2%; service revenue was $34.5m, up 8%. First-half product revenue fell 5% to $67.6m, while service revenue rose 5% to $68.3m.
- Operating expenses increased 9% to $45.5m for the quarter and 10% to $90.7m for the half, reflecting higher employee-related costs, share-based compensation, business development spending and Psytechnics costs.
- First-half operating cash flow was $17.9m, down from $30.6m. Investing activities provided $43.7m, principally reflecting marketable-security maturities; financing used $25.0m, including stock repurchases and debt repayment. Cash and cash equivalents ended at $103.9m.
- At September 30, cash, cash equivalents and marketable securities totaled $198.9m, including $17.4m of illiquid auction-rate securities. Total debt was $60.6m ($15.0m current and $45.6m long-term); no revolving-credit borrowings were outstanding. The company reported compliance with its debt covenants.
- Current assets were $242.7m and current liabilities $122.4m. Deferred revenue totaled $90.2m, current and long-term combined.
Material changes and unusual items
- Net income declined 15% in the quarter and 39% in the first half. For the half, the decline reflected $8.2m higher operating expenses and $0.9m lower gross profit, partly offset by $3.5m lower income tax expense.
- First-half product revenue was affected by a 9% decrease in units shipped; average selling price rose about 1% due partly to a shift toward higher-priced products. Service growth came mainly from maintenance renewals. Prior-year first-half service revenue included a one-time $1.0m recognition from expired training contracts.
- Psytechnics cost $17.0m in cash, including $13.2m of goodwill and $4.4m of identifiable intangible assets. It contributed $0.65m of revenue since acquisition. Fox Replay’s purchase price and financial contribution are not stated in this filing.
- The company repurchased 1.27m shares for $16.2m under its program and bought back an additional $1.6m of shares for equity-award tax withholding during the first half.
- NetScout revised prior-period cash-flow presentation for inventory transfers to fixed assets, which should have been disclosed as non-cash activity. It deemed the errors immaterial; net income and EPS were unaffected.
Outlook, risks and contingencies
- No quantified revenue or earnings guidance is provided. Management said cash, short-term securities and expected operating cash flow should cover anticipated needs, including debt service, for at least 12 months. It cautioned that a substantial decline in product demand could impair cash generation.
- Failed auctions have left $17.4m of auction-rate securities without short-term liquidity. They were valued using a discounted-cash-flow model with estimated liquidity recovery 51–55 months out. Management considers the impairment temporary and says it can hold the securities, but valuation and timing remain uncertain.
- Product backlog was $14.5m at September 30, versus an immaterial amount at March 31. Customers may cancel unshipped orders, so conversion to revenue is not assured.
- Foreign-exchange exposure is managed with forward contracts. At quarter-end, contracts had $13.2m notional value, a $0.4m liability and a $0.02m asset. Foreign-currency transaction expense increased year over year.
- Management said ordinary-course legal proceedings are not expected to have a significant adverse effect. It reported no material changes to the risk factors in the prior Form 10-K and stated disclosure controls were effective.
Most important facts for investors to verify
- Whether stronger bookings convert into reported revenue, particularly given the cancelable backlog and first-half product weakness.
- Whether expense growth moderates and margins and earnings recover following the 39% first-half net-income decline.
- The recoverability, valuation assumptions and liquidity timing for the $17.4m auction-rate securities.
- The integration, financial contribution and purchase accounting for Psytechnics and the post-quarter Fox Replay acquisition.
- Debt repayment schedule, covenant headroom and the effect of buybacks and future acquisitions on liquidity.
- The effect of the disclosed cash-flow presentation revisions when comparing prior-period cash-flow data.