NetScout Systems, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended December 31, 2017. NetScout provides service assurance and network-security solutions. Financial amounts below are in U.S. dollars; millions unless noted.
Financial performance
| Metric | Three months ended Dec. 31, 2017 | Year-over-year change | Nine months ended Dec. 31, 2017 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $268.9 | Down 11% | $751.6 | Down 11% |
| Product revenue | $153.2 | Down 20% | $417.3 | Down 21% |
| Service revenue | $115.8 | Up 5% | $334.3 | Up 5% |
| Gross profit / margin | $204.4 / 76% | Profit down 7%; margin up 3 points | $546.2 / 73% | Profit down 7%; margin up 3 points |
| Operating income | $38.3 | Up from $33.4 | $3.5 | Down from $23.4 |
| Net income | $89.7 | Up from $21.2 | $63.0 | Up from $11.0 |
| Diluted EPS | $1.02 | Up from $0.23 | $0.70 | Up from $0.12 |
| Operating cash flow | Not presented for the quarter | — | $148.9 | Up from $130.8 |
- Margins and costs: Quarterly gross margin improved on favorable product mix, including adoption of higher-margin products, and stronger service margins. Nine-month product and service gross margins were 70% and 76%, respectively, versus 67% and 74% a year earlier.
- Liquidity: Cash, cash equivalents and marketable securities totaled $383.0 at December 31, 2017, down $81.7 from March 31, 2017. Current assets were $713.5 and current liabilities $419.3.
- Debt: Long-term debt was $300.0, drawn under the revolving credit facility. NetScout reported compliance with its debt covenants at December 31, 2017.
- Cash flows and capital allocation: Nine-month investing cash flow was positive $87.9, largely reflecting marketable-security maturities. Financing cash outflow was $213.6, including $200.0 of share repurchases. Capital expenditures were $12.4 and the Efflux acquisition used $8.3 in cash.
Material changes and unusual items
- Revenue declines reflected reduced spending by a large tier-one service provider and broader service-provider capital-spending pressure, as well as delayed federal projects, longer enterprise sales cycles and weaker demand in some ancillary product lines. Product sales fell while maintenance-related service revenue grew.
- Reported net income was materially affected by the Tax Cuts and Jobs Act. NetScout recorded a provisional deferred tax benefit of approximately $83 and approximately $2 of current tax expense for the transition tax. The resulting tax benefit was $54.5 in the quarter and $69.1 for the nine-month period; the company said these provisional estimates could change. The nine-month pretax result was a loss of $6.1 despite reported net income of $63.0.
- NetScout recorded $3.6 of quarterly restructuring charges after notifying 67 employees of workforce reductions. It expected approximately $2.7 of additional termination and facility-related charges in the following nine months.
- Efflux was acquired in July 2017 for estimated consideration of $8.6, including $0.5 held in escrow. The acquisition added approximately $6.1 of goodwill.
- In October 2017, a jury found for Packet Intelligence and awarded $5.75 in damages, intended as a running royalty. The court had not entered final judgment or ruled on equitable issues. NetScout described the loss as reasonably possible and estimated exposure from zero to the jury award, plus potential interest and court adjustments.
Outlook and management commentary
- Management expected current revenue pressures to continue through the fourth quarter of fiscal 2018, including service-provider spending constraints, federal funding delays and longer sales cycles. No specific revenue or earnings guidance figures are provided in the filing text.
- Management expected fourth-quarter fiscal 2018 operating cash flow to remain relatively flat. Over the next 12 months, it expected operating cash flow to increase with anticipated higher revenues and collections, partly offset by cash operating expenses.
- Management stated that cash, available debt and future operating cash flows should be sufficient for working capital and capital expenditures for at least the next 12 months. It also noted potential uses of cash for acquisitions or investments.
- Topic 606 was scheduled to take effect April 1, 2018. NetScout expected a reduction in deferred revenue at adoption and a greater proportion of product revenue recognized upon delivery; the impact was still being quantified. The company did not expect a material cash-flow impact.
- After quarter-end, NetScout amended its credit agreement to a five-year, $1.0 billion secured revolving facility. On February 1, 2018, it announced a $300 million accelerated share repurchase and borrowed $300 million under the amended facility to fund the initial payment.
Key facts for investors to verify
- How quickly service-provider spending and delayed federal/enterprise projects recover, and whether revenue pressure persists beyond fiscal Q4 2018.
- The final tax impact of the Tax Cuts and Jobs Act, including any changes to the provisional deferred tax benefit and transition-tax estimate.
- The final outcome and potential total exposure in the Packet Intelligence case, including interest and court adjustments.
- The effect of the $300 million accelerated share repurchase and additional borrowing on debt, interest expense and remaining repurchase capacity.
- The final transition impact of Topic 606 on deferred revenue, revenue timing and sales-commission accounting.
- Whether restructuring charges and expected additional costs produce the anticipated efficiencies without impairing product development or sales execution.