Business context and reporting period
NetScout Systems, Inc. designs and sells integrated hardware and software for network service delivery, assurance and application performance management. This unaudited Form 10-Q covers the three and nine months ended December 31, 2013, corresponding to fiscal Q3 and the first nine months of FY2014. The company reports one operating segment.
Financial performance
Amounts are in U.S. dollars; financial statement amounts below are in millions except per-share data.
| Metric | Three months ended Dec. 31, 2013 | Three months ended Dec. 31, 2012 | Nine months ended Dec. 31, 2013 | Nine months ended Dec. 31, 2012 |
|---|---|---|---|---|
| Revenue | $110.4 | $91.6 | $284.3 | $252.5 |
| Gross profit / margin | $86.8 / 79% | $72.4 / 79% | $224.1 / 79% | $199.5 / 79% |
| Operating income | $27.3 | $17.6 | $52.0 | $42.7 |
| Net income | $17.3 | $11.1 | $32.4 | $26.1 |
| Diluted EPS | $0.41 | $0.26 | $0.77 | $0.62 |
- Quarterly revenue increased 21% year over year: product revenue rose 30% to $68.6 million and service revenue rose 8% to $41.9 million. Management attributed product growth to higher sales in the service-provider sector, 30% more units shipped and a 15% increase in average selling price per unit.
- Nine-month revenue grew 13%; product revenue increased 18% and service revenue 6%. Quarterly operating income increased 55% and net income increased 55%; for the nine-month period, operating income increased 22% and net income 24%.
- Quarterly gross margin held at 79%; product margin improved to 79% from 77%, while service margin declined to 78% from 82%. For nine months, product margin was 78% versus 77%, and service margin was 80% versus 82%.
- Operating cash flow for the nine months was $60.8 million, down from $67.0 million. Investing activities used $48.8 million and financing activities used $23.1 million; cash and cash equivalents decreased $11.3 million to $88.6 million.
- Cash, cash equivalents and marketable securities totaled $182.2 million at December 31, 2013, up from $154.1 million at March 31, 2013. Current assets were $248.6 million and current liabilities $150.8 million.
- No debt was outstanding under the $250 million revolving credit facility. It matures in November 2016; the company reported covenant compliance. Nine-month share repurchases and employee tax-withholding share purchases used a combined $25.0 million.
Changes, outlook and risks
- Quarterly growth was concentrated in U.S. revenue, which rose 29%; international revenue declined 4%. For the nine-month period, U.S. revenue grew 15% and international revenue 7%.
- Operating expenses increased 9% in the quarter and 10% over nine months, including higher R&D, sales and marketing, employee and share-based compensation costs. Prior-year nine-month results included $1.1 million of restructuring charges; none were recorded in the current nine-month period.
- Management expected continued service-provider growth through FY2014 and single-digit service revenue growth. It expected overall gross margin to remain relatively flat, FY2014 operating cash flow to be in line with FY2013, and capital expenditures to follow prior-year trends. No specific full-year revenue or EPS target is provided in the filing.
- Management cited the nGeniusONE platform launch and its strategy to grow in wireless service providers and enterprise application performance management. Comparisons are affected by acquisitions, including ONPATH and Accanto; the company reported $9.0 million of revenue directly attributable to those businesses during the nine months.
- One direct customer represented more than 10% of revenue in both the quarter and nine-month period; two direct customers each exceeded 10% of accounts receivable at period-end. A customer default could affect collections.
- Simena-related contingent liabilities were $4.2 million for future consideration and $98,000 for contractual non-compliance at December 31. Revised fair-value estimates reduced contingent liabilities by $289,000, recorded in earnings for the nine months.
- A California Attorney General investigation continues into potential antitrust violations involving a former employee and third parties in fiscal 2012 government sales. NetScout said the DOJ does not intend to act against the company; no agency charges or proceedings against it had been initiated. Management believes the matter is not material. Other risk factors were unchanged from the FY2013 Form 10-K.
- Management said available liquidity and expected operating cash flows should meet working-capital and capital-expenditure needs for at least 12 months. Acquisitions or investments remain possible; additional securities could be issued if existing liquidity proves insufficient.
Important facts for investors to verify
- Whether product growth and the service-provider pipeline continued after the December quarter, and whether the gains reflect sustainable demand and pricing.
- How service costs, support staffing and service gross margin evolve as the installed base expands.
- Customer concentration, receivables collection and inventory growth; operating cash flow was lower year over year despite higher net income.
- Underlying performance excluding acquisition-related accounting, acquired-intangible amortization, share-based compensation and other adjustments. The filing’s non-GAAP measures exclude specified items and should be considered alongside GAAP results.
- Developments in the California investigation and the outcome and payment timing of Simena-related contingent liabilities.
- Future capital allocation, including buybacks, acquisitions and use of the unused credit facility.