NetScout Systems, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended December 31, 2011. The interim financial statements are unaudited; amounts below are in U.S. dollars.
Business context and results
NetScout sells network visibility, service assurance and application performance solutions, with product and support-service revenue. It reported one operating segment. During the period it acquired Psytechnics, Replay and Simena, expanding voice/video monitoring, session reconstruction and network traffic-control capabilities.
| Metric | Three months ended Dec. 31, 2011 | Year-over-year change | Nine months ended Dec. 31, 2011 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $83.3 million | +9% | $219.2 million | +3% |
| Gross profit / margin | $66.1 million / 79% | +$5.8 million; margin flat | $172.5 million / 79% | +$4.9 million; margin flat |
| Operating income / margin | $17.4 million / 20.9% | +$1.2 million | $33.2 million / 15.2% | -$7.9 million |
| Net income | $10.0 million | -10% | $19.5 million | -26% |
| Diluted EPS | $0.24 | vs. $0.26 | $0.46 | vs. $0.62 |
| Operating cash flow | Not separately provided for the quarter | — | $43.9 million | vs. $44.7 million |
Financial position and material changes
- Revenue mix: Quarterly product revenue rose 7% to $46.0 million and service revenue rose 12% to $37.3 million. For the nine months, product revenue declined 1% to $113.6 million while service revenue increased 7% to $105.6 million. Management attributed product trends partly to a shift toward higher-priced Infinistream products; units shipped declined 18% over the nine-month period.
- Expenses and earnings: Nine-month operating expenses increased 10% to $139.3 million, including higher employee-related costs, share-based compensation, acquisition integration and business development expenses. Nine-month net income fell despite higher revenue and gross profit. Quarterly net income also declined, reflecting higher operating expenses, tax expense and interest and other expense.
- Cash, investments and liquidity: At December 31, cash and cash equivalents were $102.8 million; marketable securities totaled $89.5 million, for combined cash and securities of $192.3 million, down from $228.5 million at March 31, 2011. Current assets were $236.7 million and current liabilities $120.1 million. Management said available cash, short-term securities and expected operating cash flows should cover anticipated needs for at least 12 months.
- Debt: NetScout replaced its prior facility with a $250 million revolving credit facility maturing in November 2016 and drew approximately $62 million. The balance sheet reported $62.0 million of long-term debt and no current debt. The facility is secured by company and domestic subsidiary assets and includes financial covenants; the company reported compliance at quarter-end. Refinancing caused a $0.69 million debt-extinguishment loss.
- Cash uses and acquisitions: Nine-month investing cash flow was $17.4 million, largely reflecting marketable-security maturities and purchases, offset by $46.7 million of business acquisitions and $7.9 million of fixed-asset purchases. Financing cash flow was a $25.7 million outflow, including $17.9 million of treasury-stock repurchases and debt repayments, offset in part by new borrowing. The acquisitions increased goodwill to $170.0 million and net intangible assets to $56.4 million.
Outlook, risks and unusual items
- Bookings and outlook: Management reported bookings up 41% year over year in the quarter and up 33% for the nine months, led by service-provider business, particularly carriers in Asia and the United States. No quantified revenue or earnings guidance was provided. Management noted that a substantial decline in product demand could impair cash generation.
- Acquisition-related estimates: Simena consideration included $10.1 million paid at closing and contingent consideration initially valued at $8.0 million, with up to $10.8 million potentially payable subject to specified adjustments. The company also recorded a $1.6 million Simena contractual non-compliance liability; purchase-price allocations remained subject to refinement.
- Illiquid investments: Auction-rate securities had an estimated fair value of $17.1 million versus $19.3 million par value. Failed auctions have limited liquidity since 2008; the reported $2.1 million unrealized decline was treated as temporary. Management said it intended and was able to hold the securities, but fair value and timing of liquidity depend on estimates and market conditions.
- Other risks and items: Europe revenue declined amid regional economic conditions. Foreign-currency exposure is partly hedged with forward contracts; the company reported a $540,000 derivative liability at quarter-end. Management said ordinary-course legal proceedings were not expected to have a significant adverse effect. It also disclosed immaterial prior-period cash-flow presentation errors involving inventory transfers to fixed assets; revisions did not affect earnings or EPS. Disclosure controls were reported effective.
Important facts for investors to verify
- Whether bookings growth converts to revenue, particularly given cancelable unshipped orders and product backlog of $12.7 million.
- Acquisition integration, purchase-price allocation, contingent payments and the contribution of acquired businesses to reported growth and expenses.
- Trends in operating expenses, service margins, product volumes and the effect of the higher effective tax rate.
- Liquidity and valuation developments for auction-rate securities, and compliance with the secured credit facility’s covenants.
- The reported cash-flow revisions and the basis for management’s conclusion that the errors were immaterial.