NetScout Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended December 31, 2018. Financial statements are unaudited. Amounts below are in U.S. dollars; “m” means million.
Business context and reporting period
NetScout provides network performance, service assurance and security solutions to service providers, enterprises and government customers. It reports one operating segment. The company attributed weaker revenue primarily to service-provider spending constraints and project timing, with additional effects from the September 2018 sale of its handheld network test (HNT) tools business.
Financial results
| Metric | Three months ended Dec. 31, 2018 | Three months ended Dec. 31, 2017 | Nine months ended Dec. 31, 2018 | Nine months ended Dec. 31, 2017 |
|---|---|---|---|---|
| Revenue | $246.0m | $268.9m | $674.9m | $751.6m |
| Gross profit / margin | $176.4m / 72% | $204.4m / 76% | $479.3m / 71% | $546.2m / 73% |
| Operating income (loss) | $(0.6)m | $38.3m | $(100.8)m | $3.5m |
| Net income (loss) | $(3.6)m | $89.7m | $(92.5)m | $63.0m |
| Diluted EPS | $(0.05) | $1.02 | $(1.17) | $0.70 |
- Quarterly product revenue fell 8% to $134.1m and service revenue fell 9% to $111.9m. For the nine-month period, product revenue declined 14% to $341.8m and service revenue declined 6% to $333.1m.
- Quarterly operating expenses rose 7% to $177.1m, including $13.9m of restructuring charges. Nine-month expenses included $35.9m of intangible-asset impairment, $17.5m of restructuring charges and a $9.2m loss on the HNT divestiture.
- For the quarter, non-GAAP diluted EPS was $0.45 versus $0.69; for nine months it was $0.72 versus $1.05. These company-defined non-GAAP measures exclude specified items and should be considered alongside GAAP results.
- Nine-month operating cash flow was $69.5m, down from $148.9m. Capital expenditures were $19.5m. Cash, cash equivalents and marketable securities totaled $475.8m at December 31, 2018, versus $447.8m at March 31, 2018.
- Current assets were $802.2m and current liabilities were $386.4m. Long-term debt was $600.0m, outstanding under a $1.0bn secured revolving facility. The company reported compliance with debt covenants. On February 4, 2019, it repaid $50.0m of borrowings.
Material changes and unusual items
- Revenue declined 9% in the quarter and 10% over nine months. Management cited constrained service-provider capital spending, project timing, lower demand across service assurance and security, legacy service revenue declines, and the HNT sale.
- The nine-month net result moved from $63.0m income to a $92.5m loss. Management cited a $45.6m smaller income tax benefit, the $35.9m impairment, increased incentive compensation and restructuring costs, higher interest expense, and the HNT divestiture loss.
- The company adopted revenue standard Topic 606 on April 1, 2018 using the modified retrospective method; prior-year comparisons were not restated. Adoption increased opening retained earnings by $34.1m. For the nine months, it increased reported revenue by $10.3m and reduced the reported net loss by $7.7m compared with amounts calculated without adoption.
- HNT divestiture consideration included $1.3m cash and contingent earnout consideration with a reported fair value of $2.3m, dependent on milestones. NetScout recorded a $9.2m divestiture loss and expects transition services to continue for up to 18 months.
Outlook, risks and contingencies
- Management expects fiscal 2019 operating cash flow to be lower than fiscal 2018, citing working-capital changes and lower sales volumes. It expects available cash, securities, debt capacity and operating cash flows to cover anticipated working capital and capital expenditures for at least the next 12 months.
- Management said challenging market conditions—including service-provider capital-spending pressure and enterprise uncertainty over digital-transformation initiatives—are likely to persist, potentially contributing to longer sales cycles, order delays and volume changes. No specific revenue or earnings guidance was provided in the filing text.
- Packet Intelligence patent litigation remains a material uncertainty. The court entered judgment following a jury verdict, enhanced the verdict by $2.8m, and awarded interest and a running royalty on specified products through patent expiry, as late as June 2022. NetScout is pursuing post-judgment motions and may appeal. The company describes the loss risk as reasonably possible and estimates a range from $0 to the aggregate jury award, plus potential interest and costs.
- Verizon represented more than 10% of quarterly revenue and more than 10% of receivables at December 31, 2018. The company also identified foreign-currency and floating-rate debt exposure; it uses forward contracts to hedge certain foreign-currency costs.
- The company expects adoption of lease accounting standard ASC 842 beginning April 1, 2019 to materially affect its balance sheet; it does not expect a material effect on results of operations or cash flows.
Important facts for investors to verify
- Whether revenue trends improve, particularly in service-provider markets, and whether enterprise initiatives translate into orders.
- The cash-flow and margin trajectory, including the effects of incentive compensation, restructuring and lower sales volumes.
- Debt repayment plans, borrowing costs, covenant headroom and the impact of the February 2019 repayment.
- The outcome and potential financial exposure of the Packet Intelligence case, including royalties, interest and costs.
- HNT earnout milestone performance and the timing and financial impact of remaining restructuring payments.
- How Topic 606 and ASC 842 affect comparability, reported assets, liabilities and future results.