NetScout Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal first quarter ended June 30, 2013; comparisons are with the three months ended June 30, 2012 unless otherwise noted. Dollar amounts are in millions except per-share data.
Business context
NetScout sells integrated hardware and software for network monitoring, service assurance and application performance management. It reports one operating segment. During the quarter, it announced the nGeniusONE platform, which combines application and network performance management. The company said its strategy focuses on wireless service-provider market share and enterprise growth.
Financial performance and liquidity
| Metric | Q1 FY2014 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $81.8 | $76.4 | +7% |
| Product revenue | $43.0 | $40.3 | +7% |
| Service revenue | $38.8 | $36.1 | +8% |
| Gross profit / gross margin | $64.9 / 79% | $59.5 / 78% | +9%; margin +1 point |
| Operating income | $8.9 | $8.2 | +8% |
| Net income | $5.3 | $5.0 | +5% |
| Diluted EPS | $0.12 | $0.12 | Unchanged |
| Operating cash flow | $18.6 | $36.1 | Down $17.5 |
Non-GAAP diluted EPS was $0.21 versus $0.19; non-GAAP net income was $8.7 versus $8.1. These company-defined measures exclude specified acquisition, share-based compensation, amortization, integration and other items, net of tax; they are not substitutes for GAAP results.
Operating expenses rose 9% to $56.0, led by research and development (+13%) and sales and marketing (+7%). Effective tax rate was 40.4%, compared with 36.3%; management attributed the higher rate principally to foreign losses for which no tax benefit could be recognized, partly offset by reinstatement of the R&D credit.
At June 30, cash and cash equivalents were $102.7 and marketable securities totaled $60.1, for combined liquidity of $162.8, up $8.7 from March 31. Current assets were $229.2 and current liabilities $132.7. No borrowings were outstanding under the $250 revolving credit facility, which matures in November 2016; the company reported compliance with its covenants. Cash increased $2.8 during the quarter after operating cash flow, investing outflows of $8.4 and financing outflows of $7.4.
Material changes and management commentary
- U.S. revenue rose 14% to $62.8, while international revenue fell 11% to $19.0. Management cited declines in international government and general enterprise sales. One direct customer represented more than 10% of quarterly revenue.
- Product revenue increased despite units shipped falling 17%; average selling price rose 25%, which management attributed to product mix. Service revenue growth reflected more maintenance and premium-support contracts as well as training.
- Operating cash flow was lower year over year, with management citing the timing of compensation and other payments, inventory growth and deferred-tax effects. DSO was 55 days, versus 68 at March 31, 2013 and 45 a year earlier.
- Share repurchases used $7.5 of cash, including $5.9 under the public program; an additional $1.6 related to employee tax withholding. The company had 993,707 shares remaining under the repurchase authorization at quarter-end.
- Acquisitions of ONPATH and Accanto contributed $5.0 of revenue in the quarter. The company paid $0.8 of Simena contingent consideration; a $0.3 reduction in contingent-liability fair value was recognized in earnings.
Outlook, risks and contingencies
- Management expected continued revenue growth in fiscal 2014, with service-provider sales a significant growth driver; it expected single-digit service-revenue growth and gross margin to remain relatively flat.
- Management expected fiscal 2014 operating cash flow to be in line with fiscal 2013 and capital expenditures to follow prior-year trends. It said existing liquidity and future operating cash flows should cover anticipated needs for at least 12 months.
- The company faces foreign-exchange exposure, principally to the euro, pound, Canadian dollar and Indian rupee, and used forward contracts with $10.3 notional value. It stated derivatives are used for hedging, not speculation.
- A California Attorney General investigation continues into potential antitrust violations involving a former employee and third parties in fiscal 2012 state-agency sales. NetScout reported cooperating, said the amounts involved were not believed material, and stated the Department of Justice did not intend to take action against it. An immaterial liability was accrued.
- Simena acquisition-related liabilities at June 30 included $4.1 of contingent purchase consideration and $0.2 for contractual non-compliance. The company also disclosed ordinary-course legal claims, which management did not expect to have a significant adverse effect.
- Management said there had been no material changes to the risk factors in the fiscal 2013 Form 10-K. It also cautioned that interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether revenue growth and product pricing/mix trends persist, particularly given the decline in units shipped and international sales.
- Whether operating cash flow recovers from the year-over-year decline and inventory increase; monitor DSO and deferred revenue.
- Whether the company achieves its fiscal 2014 expectations for growth, service revenue, margins, cash flow and capital expenditures.
- Customer concentration and the potential impact if the customer representing more than 10% of revenue or receivables reduces purchases or delays payment.
- Progress and potential financial exposure from the California antitrust investigation and Simena contingent obligations.
- Acquisition integration, goodwill and intangible-asset valuations, and the impact of ongoing amortization and share-based compensation on GAAP results.