NetScout Systems, Inc. — Form 10-Q Summary
Reporting period: Third quarter and nine months ended December 31, 2014; fiscal year ends March 31. Amounts below are in U.S. dollars.
Business context and financial performance
NetScout provides network, application and service assurance products and services. It reports one operating segment. Results are unaudited and compared with the same prior-year periods.
| Metric | Q3 FY2015 | Q3 FY2014 | Nine months FY2015 | Nine months FY2014 |
|---|---|---|---|---|
| Revenue | $122.8 million | $110.4 million | $334.3 million | $284.3 million |
| Gross profit / margin | $95.9 million / 78% | $86.8 million / 79% | $263.1 million / 79% | $224.1 million / 79% |
| Operating income / margin | $27.9 million / 23% | $27.3 million / 25% | $66.2 million / 20% | $52.0 million / 18% |
| Net income | $17.6 million | $17.3 million | $40.3 million | $32.4 million |
| Diluted EPS | $0.42 | $0.41 | $0.97 | $0.77 |
| Operating cash flow | Not separately reported for the quarter | $57.3 million | $60.8 million |
For the quarter, product revenue rose 12% to $76.4 million and service revenue rose 11% to $46.4 million. For the nine months, product revenue increased 21% and service revenue 13%. Nine-month revenue grew across service-provider, government-enterprise and general-enterprise customers. International revenue was 28% of quarterly sales and 24% for the nine-month period.
Q3 non-GAAP net income was $24.6 million and non-GAAP diluted EPS was $0.59, compared with $21.0 million and $0.50 a year earlier. Nine-month non-GAAP net income was $56.4 million and diluted EPS was $1.35, versus $44.0 million and $1.05. These company-defined measures exclude specified acquisition-related items, share-based compensation, acquired-intangible amortization and related tax adjustments; they are not GAAP substitutes.
Balance sheet, liquidity and debt
- At December 31, cash and cash equivalents were $106.7 million; short- and long-term marketable securities were $88.0 million and $46.1 million. Combined liquidity of $240.7 million was up $21.9 million from March 31, 2014.
- Current assets were $315.2 million and current liabilities $168.9 million. Current deferred revenue was $107.6 million, with another $27.0 million long-term.
- No borrowings were outstanding on the $250 million revolving credit facility, which matures November 2016. The company reported compliance with its covenants.
- Nine-month investing cash outflow was $26.0 million, including $8.6 million of capital expenditures; financing cash outflow was $27.1 million, including $31.5 million for treasury-stock repurchases. Cash and cash equivalents increased $4.6 million over the period.
Material changes, outlook and risks
- Quarterly revenue increased 11%, but gross margin fell one percentage point and operating margin declined two points. Net income increased 2%. Quarterly G&A expense rose 69%, principally reflecting $4.6 million of business-development costs for the proposed Danaher transaction. Product cost included a $1.8 million increase in obsolescence charges.
- Management cited higher accounts receivable as a major factor in lower operating cash flow year over year. Days sales outstanding was 62 at December 31, compared with 47 at March 31 and 61 a year earlier.
- Management expected growth across major sectors through fiscal 2015, continued service-revenue growth as the installed base expands, and gross margin to remain relatively flat. It expected operating cash flow to increase with collections on anticipated higher revenue, partly offset by higher cash operating expenses; capital expenditures were expected to be in line with prior years. Management stated liquidity should cover anticipated needs for at least 12 months. No numerical earnings or revenue guidance was provided.
- The proposed Reverse Morris Trust acquisition of Danaher’s communications business, including Tektronix Communications, Fluke Networks and Arbor Networks, was expected to close in the first half of NetScout fiscal 2016. The transaction contemplated issuing 62.5 million shares, representing approximately 59.5% of post-transaction shares, subject to specified adjustments. NetScout had incurred $6.2 million of acquisition-related costs in the nine-month period. A $55 million termination fee could apply in specified circumstances.
- The Department of Justice issued a second request for information on December 24, 2014, extending the antitrust review waiting period. Closing also required stockholder, regulatory and other approvals; the filing cautioned that delay, failure to close, or imposed conditions could adversely affect the business and expected benefits.
- Other risks include foreign-exchange exposure and marketable-securities credit risk. NetScout used forward contracts with $19.8 million notional value for hedging, not speculation. Management said ordinary-course legal matters were not expected to have a significant adverse effect. The filing reported no off-balance-sheet arrangements.
Most important facts for investors to verify
- Progress, closing conditions, dilution and potential termination-fee exposure for the Danaher transaction, including the DOJ review.
- Whether higher days sales outstanding converts to cash and operating cash flow recovers.
- Whether product-margin pressure and inventory obsolescence charges persist, and how acquisition costs affect GAAP results.
- Use of the remaining $88.5 million repurchase authorization alongside acquisition funding and liquidity needs.
- The impact of foreign-exchange movements, acquisition integration and the forthcoming revenue-recognition standard; the company was still evaluating the standard’s impact.