NetScout Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal 2016 third quarter, three months ended December 31, 2015; year-to-date results cover the nine months ended December 31, 2015. Amounts are in U.S. dollars unless noted. The Danaher Communications Business acquisition closed July 14, 2015, so comparisons with 2014 are not like-for-like.
Business context and financial performance
NetScout provides network service assurance and cybersecurity solutions. It acquired selected communications businesses from Danaher, including Tektronix Communications, Arbor Networks, VSS Monitoring and parts of Fluke Networks Enterprise, in a transaction valued at approximately $2.3 billion, primarily paid in NetScout shares. The filing says the transaction is intended to expand addressable markets and strengthen the company’s product portfolio and customer reach.
| Metric | Three months ended Dec. 31, 2015 | Nine months ended Dec. 31, 2015 |
|---|---|---|
| Revenue | $307.7 million, up 150% year over year | $669.5 million, up 100% |
| Gross profit / margin | $201.6 million / 66%, versus 78% | $441.9 million / 66%, versus 79% |
| Operating income (loss) | $2.3 million, versus $27.9 million | $(20.6) million, versus $66.2 million |
| Net income (loss) | $(24.5) million, versus $17.6 million | $(24.8) million, versus $40.3 million |
| Diluted EPS | $(0.25), versus $0.42 | $(0.32), versus $0.97 |
| Operating cash flow | Not separately presented in the filing’s quarterly cash flow statements | $56.6 million, versus $57.3 million |
Quarterly product and service revenue were $209.1 million and $98.6 million, respectively. For the nine months, product revenue was $437.6 million and service revenue was $231.9 million. The acquisition contributed $331.5 million of revenue and a $49.1 million net loss to year-to-date results, according to the filing. Management’s non-GAAP reconciliation reports third-quarter net income of $57.2 million and diluted EPS of $0.58; nine-month non-GAAP net income was $114.5 million and diluted EPS was $1.47. These measures exclude specified acquisition, amortization, stock-compensation and other items and should be considered alongside GAAP results.
Liquidity, debt and cash flow
- At December 31, 2015, cash and cash equivalents were $230.5 million and marketable securities were $145.7 million, totaling $376.2 million, up $111.3 million from March 31, 2015.
- Current assets were $753.9 million and current liabilities were $433.1 million. Deferred revenue and customer deposits totaled $312.4 million, current and long-term.
- Long-term debt was $250 million under a new five-year, $800 million senior secured revolving credit facility maturing July 2020. The reported rate was 2.18%. The company was in compliance with its covenants at quarter-end.
- Nine-month cash from operations was $56.6 million; investing activities provided $35.3 million and financing activities provided $34.0 million. The financing total included $244.6 million of net debt proceeds and was offset in part by $212.4 million of share repurchases.
- NetScout repurchased 5.2 million shares for $201.0 million under its new 20-million-share authorization through December 31. It said it intended to repurchase approximately $100 million of shares in fiscal Q4.
Changes, outlook and risks
- Revenue growth largely reflects the acquired business: management attributed $115.5 million of third-quarter product growth and $47.2 million of service growth to the acquisition. Higher acquisition-related costs and acquired intangible amortization contributed to lower margins and GAAP earnings.
- Management cited continued service revenue growth as the installed base expands. It expects future revenue mix to lean toward service-provider customers, while noting that project timing may affect quarterly mix. It also expects international markets to represent a significant share of revenue and estimates roughly one-third of combined-company revenue will come from outside North America.
- No specific revenue or earnings guidance was provided. Management said cash, available borrowing capacity, marketable securities and operating cash flow should cover anticipated working capital and capital needs for at least 12 months; it also expects operating cash flow to increase with collections, partly offset by higher cash operating expenses.
- The acquisition’s purchase price allocation remains preliminary and could be adjusted during the measurement period, with potentially material effects on assets, liabilities and goodwill. Goodwill and acquired intangibles are substantial; acquired goodwill and intangibles are not tax-deductible.
- Key risks include integration execution, continued transaction and integration costs, possible asset write-downs, distraction of management, foreign currency exposure, and debt-related interest-rate, covenant and liquidity risks. The filing reports ordinary-course legal matters that management does not expect to have a significant adverse effect.
- The quarter’s income tax expense was $23.9 million despite a pretax loss of $0.7 million, producing a reported effective tax rate of 3,670.3%. Management attributed unusual tax rates to low pretax income, transaction expenses, acquired-company tax credits and changes in jurisdictional earnings mix.
Most important facts for investors to verify
- Whether the acquired businesses can be integrated and deliver the expected strategic benefits, revenue growth and eventual cost efficiencies.
- How much of reported growth and non-GAAP profitability is acquisition-driven, and how acquisition-related adjustments reconcile to GAAP results.
- Whether gross margins stabilize after the acquisition-related declines, including the effects of deferred-revenue and inventory fair-value adjustments and acquired-intangible amortization.
- Cash generation, working-capital trends and share repurchases relative to the $250 million debt balance, facility covenants and planned additional repurchases.
- Final purchase accounting, including goodwill and intangible valuations, and the sustainability of the unusually low or volatile effective tax rate.