NetScout Systems, Inc. — FY2016 Form 10-K
Reporting period: Fiscal year ended March 31, 2016 (including the quarter ended March 31, 2016). The company’s results include approximately eight and one-half months of the acquired Danaher Communications Business; year-over-year comparisons are therefore not like-for-like.
Business context
NetScout provides network performance, service assurance and cybersecurity products and services to enterprise, service-provider and government customers. On July 14, 2015, it acquired Danaher’s Communications Business—including assets from Tektronix Communications, Arbor Networks, VSS Monitoring and parts of Fluke Networks Enterprise—in a stock transaction valued at approximately $2.3 billion. The acquisition substantially expanded the company’s scale and product portfolio.
Financial performance and liquidity
| Metric | FY2016 | FY2015 |
|---|---|---|
| Revenue | $955.4 million | $453.7 million |
| Gross profit / margin | $627.0 million / 66% | $359.1 million / 79% |
| Operating income (loss) | $(25.6) million | $96.8 million |
| Net income (loss) | $(28.4) million | $61.2 million |
| Diluted EPS | $(0.35) | $1.47 |
| Cash from operations | $95.3 million | $106.9 million |
- Product revenue grew 132% to $633.4 million; service revenue grew 78% to $322.0 million. The acquisition drove most of the increases: acquired operations contributed $501.9 million of revenue and a $65.4 million net loss during the period included in NetScout’s results.
- Gross margin fell 13 percentage points. Product margin was 62% versus 78%; service margin was 72% versus 80%. The company cited the acquired business’s cost structure and purchase-accounting effects as significant factors.
- GAAP operating loss reflected sharply higher expenses, including acquisition-related integration and compensation costs and acquired-intangible amortization. The company reported non-GAAP net income of $157.4 million and diluted EPS of $1.91, versus $84.3 million and $2.03, respectively, in FY2015; these measures exclude specified acquisition, amortization, share-based compensation and other items.
- Cash, cash equivalents and marketable securities totaled $352.1 million, up $87.2 million year over year; working capital was $283.4 million. Cash from operations declined by $11.6 million. Accounts-receivable days sales outstanding rose to 80 days from 61.
- Debt was $300 million at year-end under a $800 million senior secured revolving facility expiring in 2020. The filing reports a 2.19% interest rate and compliance with debt covenants. Cash and marketable securities exceeded debt by approximately $52.1 million.
- The company repurchased $300 million of shares under its 20-million-share authorization during FY2016. No cash dividends were declared, and none were anticipated in the foreseeable future.
Changes, outlook and material risks
- Revenue more than doubled, primarily because of the acquisition, while GAAP results shifted from profit to loss and gross margin contracted. The filing’s unaudited pro forma figures—which assume the acquisition occurred at the start of FY2015—show revenue of $1.132 billion and a net loss of $58.8 million for FY2016, versus revenue of $1.178 billion and a net loss of $2.3 million for FY2015; these figures are not actual reported results or a forecast.
- Management expected a modest improvement in operating margin in FY2017 and expected operating cash flows to increase with higher anticipated revenue and collections, partly offset by higher cash operating expenses. No specific numerical revenue or earnings guidance was provided in the supplied filing text.
- Management planned further product integration and cost efficiencies, including new integrated offerings over the following 12–24 months. The company cautioned that integration costs and projected synergies had not been estimated.
- Key risks include successful integration and retention of acquired employees and customers; achieving expected growth and cost savings; competition and rapid technology change; cybersecurity and product-quality issues; foreign-exchange exposure; reliance on some sole-source components; and economic or customer spending pressures.
- Goodwill and acquired intangible assets rose substantially following the transaction. Purchase accounting remained subject to measurement-period adjustments, particularly for deferred taxes, pension obligations and goodwill. The annual impairment review found no impairment as of January 2016.
- Management and the auditor concluded internal control over financial reporting was effective, but the assessment and audit excluded acquired Fluke Networks Enterprise, Tektronix Communications and VSS operations—9% of total assets and 34% of FY2016 revenue—which were still being integrated into control processes.
- The company assumed unfunded non-U.S. pension obligations; future funding needs could affect liquidity. Management said ordinary-course legal proceedings were not expected to have a significant adverse financial effect.
Important facts for investors to verify
- How much of future revenue and margin performance is organic versus attributable to the acquired businesses, and whether integration produces the expected growth and cost synergies.
- Whether gross margins and operating margins improve as management anticipated, given acquisition-related expenses and the scheduled amortization of acquired intangibles.
- Whether receivables convert to cash as expected, particularly with DSO at 80 days and a $44.2 million receivable from Danaher at year-end.
- Debt, interest costs and covenant headroom under the secured facility, alongside continued share repurchases and pension-funding requirements.
- Progress in integrating acquired businesses’ financial controls, systems and operations, and any material purchase-accounting adjustments or impairment indicators.