NETSCOUT SYSTEMS, INC. — Q2 FY2021 Form 10-Q
Reporting period: Quarter and six months ended September 30, 2020; fiscal year ends March 31. Results are unaudited. Amounts below are in U.S. dollars.
Business context
NetScout provides service assurance and security solutions to service-provider and enterprise customers. It reports one segment. Management cited digital transformation, cybersecurity, analytics and 5G as business catalysts. COVID-19 had not materially harmed operations to date, but the company reported elongated customer purchasing cycles and anticipated effects on fiscal-year results.
Financial performance
| Metric | Q2 FY2021 | Q2 FY2020 | Six months FY2021 | Six months FY2020 |
|---|---|---|---|---|
| Revenue | $205.3m | $216.4m | $389.2m | $402.4m |
| Gross profit / margin | $146.4m / 71% | $157.3m / 73% | $277.3m / 71% | $288.6m / 72% |
| Operating income (loss) | $3.8m | $(7.3)m | $(10.7)m | $(31.7)m |
| Net loss | $(3.7)m | $(17.5)m | $(21.1)m | $(46.8)m |
| Diluted loss per share | $(0.05) | $(0.23) | $(0.29) | $(0.61) |
| Operating cash flow | Not separately stated | Not separately stated | $56.6m | $48.5m |
Quarterly product revenue fell 11% to $92.0m, while service revenue was nearly flat at $113.4m. For the six months, product revenue declined 8% to $163.7m and service revenue rose 1% to $225.5m. Six-month non-GAAP diluted net income per share was $0.55, versus $0.35 a year earlier; this is a company-defined non-GAAP measure, not GAAP earnings.
Balance sheet, debt and liquidity
- At September 30, cash and cash equivalents were $415.7m and marketable securities were $12.1m, totaling $427.8m, up from $389.1m at March 31.
- Long-term debt was $450.0m, unchanged from March 31. The reported interest rate was 1.65%; the revolving facility matures January 2023. The company was in compliance with its debt covenants.
- Management reported an additional $317m available under its $1.0bn revolving facility based on covenant levels. It expects cash, operating cash flow and borrowing availability to cover obligations and planned spending for at least 12 months.
- Current liabilities included $236.2m of deferred revenue and customer deposits; total deferred revenue was $335.8m. The company expects to recognize 70% within 12 months.
Material changes and management commentary
- Six-month revenue declined 3%, primarily from lower network performance management sales in enterprise and service-provider markets; increased DDoS revenue partly offset the decline. U.S. revenue fell 8%, while international revenue rose 4%.
- Six-month gross margin decreased one percentage point. Product gross margin improved to 71% from 68%, while service gross margin declined to 72% from 74%, reflecting higher service employee-related costs and variable incentive compensation.
- Operating expenses fell 10% for the six months, led by lower sales and marketing costs, including travel and event spending affected by COVID-19 restrictions. Net loss improved by $25.7m, helped by lower expenses and interest costs, partly offset by higher employee-related expenses.
- Management is limiting discretionary spending and hiring, and said it is managing costs to mitigate revenue pressure. It aims to deliver improved GAAP earnings per share versus the prior-year period. No quantified revenue or earnings guidance was provided.
- Six-month cash from operations increased to $56.6m, while deferred revenue declined $39.5m. Investing cash flow was positive largely because proceeds from securities maturities and sales exceeded purchases.
Risks, contingencies and unusual items
- COVID-19: Future effects on customers, suppliers, operations and financial results remained uncertain; management warned that elongated purchasing cycles and macroeconomic conditions could affect fiscal-year results.
- Patent litigation: In July 2020, an appeals court vacated a $3.5m pre-suit damages award, affirmed $2.25m of post-suit damages, and remanded the case to assess any enhancement. NetScout considers the post-suit loss probable; potential enhancement is not reasonably estimable, with a stated likely range of $0–$2.8m, in addition to interest and royalties on post-trial sales.
- UK VAT: The company recorded approximately $6.3m each in an asset and liability related to a voluntary disclosure concerning VAT application differences. Penalties may range from 0% to 30% of underpayment; the company accrued penalties it considers probable and estimable.
- Other commitments: A $0.7m Gigavation acquisition escrow liability was expected to be paid in February 2021, absent valid indemnification claims. The company deferred $7.4m of employer payroll taxes under the CARES Act, payable in installments by December 2021 and December 2022.
- Management reported no material change to the risk factors in its FY2020 Form 10-K. Disclosure controls were deemed effective; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether product demand—particularly network performance management and U.S. sales—recovers as purchasing cycles normalize.
- Whether service costs and deferred revenue trends affect future gross margin and cash conversion.
- The final liability from the Packet Intelligence litigation, including enhancement, interest and ongoing royalties.
- The outcome and final cost of the UK VAT disclosure, including any penalties.
- Debt covenant headroom, revolving-credit availability and the company’s ability to maintain liquidity if COVID-related disruption persists.