NetScout Systems, Inc. — FY2020 Form 10-K
Reporting period: Fiscal year ended March 31, 2020. The filing also reports fourth-quarter results for the three months ended March 31, 2020. Amounts below are in U.S. dollars; financial figures are in millions unless noted.
Business context
NetScout sells service-assurance, network-performance and cybersecurity products and services to enterprises, government agencies and service providers. Product revenue includes hardware and software; service revenue includes support, consulting, training and SaaS. The company reports one segment. International sales were 39% of annual revenue.
Key financial metrics
| Metric | FY2020 | FY2019 |
|---|---|---|
| Total revenue | $891.8 | $909.9 |
| Product revenue | $438.3 | $467.3 |
| Service revenue | $453.5 | $442.6 |
| Gross profit / gross margin | $649.6 / 73% | $655.8 / 72% |
| Operating income (loss) | $17.6 | $(71.6) |
| Net income (loss) | $(2.8) | $(73.3) |
| Diluted GAAP EPS | $(0.04) | $(0.93) |
| Operating cash flow | $225.0 | $149.8 |
FY2020 non-GAAP net income was $119.1 million, or $1.57 per diluted share, versus $109.2 million, or $1.38, in FY2019. These non-GAAP measures exclude substantial items, including share-based compensation and acquired-intangible amortization; they are not substitutes for GAAP results.
At March 31, 2020, cash, cash equivalents and marketable securities totaled $389.1 million, down from $487.0 million. Working capital was $260.7 million. Debt was $450.0 million, down from $550.0 million; the company reported $285 million of incremental availability under its $1.0 billion revolving facility based on covenant levels. It was in compliance with debt covenants. The reported cash-flow statement shows $19.9 million of capital expenditures.
Changes versus prior comparable periods
- Annual revenue declined 2%, as product revenue fell 6%; service revenue rose 2%, supported by new maintenance contracts and renewals.
- Product weakness reflected lower enterprise network-performance and DDoS sales, lower service-provider network-performance sales, and the HNT tools divestiture. Service growth partly offset these declines.
- Gross margin improved by about one percentage point. Operating expenses fell $95.4 million, mainly because FY2019 included $35.9 million of intangible impairment, $18.7 million of restructuring charges and a $9.5 million divestiture loss; acquired-intangible amortization also declined.
- Net loss narrowed by $70.6 million, but FY2020 included $4.7 million of tax expense versus a $19.6 million tax benefit in FY2019. The stated annual effective tax rate was 243.1%, reflecting, among other factors, foreign-subsidiary tax elections and low pretax income.
- Operating cash flow increased $75.2 million. Cash balances declined largely due to $175.0 million of share repurchases and $100.0 million of debt repayments.
- Fourth-quarter revenue was $229.4 million versus $235.0 million a year earlier; net income was $7.3 million versus $19.2 million. The filing says COVID-19 did not materially adversely affect reported Q4 results, though it affected the timing of some transactions.
Outlook, commentary, risks and unusual items
- Outlook and COVID-19: The company said the pandemic’s future financial impact could be material but could not be reasonably estimated. It cited uncertain customer order timing and risks to demand, sales activity, operations and supply chains. Management expected cash, marketable securities, operating cash flow and available borrowing capacity to cover ordinary-course needs for at least 12 months. It limited discretionary spending and hiring and temporarily halted repurchases; the authorization remained effective. No specific FY2021 revenue or earnings guidance is provided in this filing.
- Legal contingency: NetScout appealed a patent-infringement judgment in the Packet Intelligence matter. The jury awarded $5.75 million, the court added $2.8 million in enhanced damages, and the judgment includes interest and running royalties on specified legacy products through patent expiration, no later than June 2022. The company classified loss as reasonably possible and estimated a range from $0 to the awards, plus interest, costs and potential royalties.
- UK VAT: A subsidiary disclosed historical VAT application differences to HMRC and accrued estimated probable penalties. The company said it was reasonably possible HMRC could require it to collect and remit approximately £16 million from current customers; it had not recorded that amount as payable or receivable.
- Other balance-sheet considerations: Goodwill was $1.73 billion, and the company reported no impairment after a COVID-19-triggered year-end assessment. The company also had $32.8 million of unfunded non-U.S. pension obligations and $96.1 million of future operating lease payments.
- Audit and controls: PwC issued an unqualified opinion on the financial statements and concluded internal control over financial reporting was effective. Critical audit matters included revenue performance-obligation judgments and goodwill impairment assumptions.
Important facts for investors to verify
- Whether product-revenue declines stabilize and service renewals continue to offset product weakness, particularly as COVID-19 affects order timing.
- The assumptions supporting goodwill recoverability, given goodwill of $1.73 billion and sensitivity to projected revenue, margins and operating costs.
- The ultimate exposure in the appealed Packet Intelligence case, including ongoing royalties, and the outcome of the HMRC VAT matter.
- Cash generation, covenant headroom and borrowing costs on $450 million of floating-rate debt, including the transition from LIBOR after 2021.
- The sustainability of reported non-GAAP profitability relative to GAAP results and the significant exclusions, especially share-based compensation and intangible amortization.