Business context and reporting period
NetScout Systems, Inc. designs, sells and supports network service delivery, service assurance and application performance management products. This unaudited Form 10-Q covers the quarter and nine months ended December 31, 2012, the third quarter of fiscal 2013; comparisons are with the corresponding 2011 periods.
Financial performance and position
- Quarter: Revenue was $91.6 million, up 10% year over year. Product revenue rose 15% to $52.7 million; service revenue rose 4% to $38.9 million. Gross profit was $72.4 million, with gross margin steady at 79%. Operating income was $17.6 million versus $17.4 million; net income increased 11% to $11.1 million. Diluted EPS was $0.26 versus $0.24.
- Nine months: Revenue increased 15% to $252.5 million, comprising product revenue of $139.1 million (+22%) and service revenue of $113.4 million (+7%). Gross profit was $199.5 million, up 16%, and gross margin remained 79%. Operating income increased to $42.7 million from $33.2 million; net income rose to $26.1 million from $19.5 million. Diluted EPS was $0.62 versus $0.46.
- Cash flow: Operating cash flow for nine months was $67.0 million, versus $43.9 million a year earlier. Investing used $9.8 million, including $51.3 million for acquisitions, offset in part by marketable-security maturities. Financing used $83.5 million, including repayment of $62.0 million of debt and $20.7 million of treasury-stock purchases. Cash and equivalents ended at $90.8 million, down $26.4 million since March 31.
- Liquidity and debt: Cash, cash equivalents and marketable securities totaled $136.7 million, down from $213.5 million at March 31, 2012. The company had no debt outstanding at December 31 after repaying its $62.0 million balance; its $250 million revolving facility, maturing in 2016, remained available. The company reported compliance with debt covenants. Current assets were $219.5 million and current liabilities $140.4 million.
- Other metrics: Backlog was $17.3 million, compared with $13.0 million at March 31; orders may be cancellable. The estimated fiscal 2013 effective tax rate was 36.8%, versus 34.9% in the prior-year comparison.
Material changes and management commentary
- Quarterly product growth was led by general enterprise and service-provider demand; government and financial enterprise product revenue declined. Product units shipped fell 6%, while average selling price rose about 14%, mainly due to mix. Service-provider bookings grew 51% for the nine-month period, which management attributed to expanding LTE deployments.
- Nine-month new-business bookings increased 15%. Financial-enterprise bookings rose 9%, while government-enterprise bookings fell 30%, which management attributed to federal deferrals of long-term strategic initiatives.
- Operating expenses rose 13% in the quarter, including higher R&D, sales and marketing, and G&A costs. Quarterly operating income was nearly flat year over year despite revenue growth. Nine-month operating expenses increased 13%.
- NetScout acquired Accanto for $15.0 million in July 2012 and ONPATH for $36.8 million in cash in October, with additional ONPATH employee compensation to be paid in the future. Acquired businesses contributed $15.6 million of revenue in the nine-month period. Acquisition activity increased goodwill and acquired-intangible amortization.
- The company repaid all outstanding debt, completed the redemption of its remaining auction-rate securities, and held none at quarter-end. It repurchased $17.0 million of shares under its buyback program during the nine months, in addition to shares withheld for employee taxes.
Outlook, risks and contingencies
- Management said available cash, short-term investments and expected operating cash flow should meet anticipated working-capital, capital-expenditure and debt-interest needs for at least 12 months. It expected operating cash flow to increase with anticipated revenue and collections, partly offset by cash operating expenses. The filing provides no clear quantified revenue or earnings guidance.
- Management expects service providers to remain a significant growth driver and plans continued capital investment. It may use cash for further acquisitions or investments; if liquidity proves insufficient, it may seek additional debt or equity financing, potentially diluting shareholders.
- Government-sector demand is a risk given the reported booking decline and federal project deferrals. Backlog is not assured revenue because customers can generally cancel unshipped orders. The business also faces competition, product-acceptance and acquisition-integration risks; management said there were no material changes to the risk factors in its prior Form 10-K.
- Former Accanto employees alleged Italian employment-law violations and sought transfer to NetScout. The company considered a related liability probable, accrued an immaterial amount and said the maximum potential liability was also immaterial.
- A California Attorney General investigation concerns potential federal and state antitrust violations involving a former employee and third parties in fiscal 2012 government sales. NetScout said it was cooperating, had accrued an immaterial liability, and had been informed that the Department of Justice did not intend to take action against the company; no charges or proceedings had been initiated.
- Other notable items include $1.2 million of nine-month restructuring charges, primarily severance following Accanto-related sales-force overlap, and a $249,000 inventory fair-value adjustment related to ONPATH. The company expected a tax benefit in the March 2013 quarter following extension of the R&D tax credit.
Important facts for investors to verify
- Whether product growth, pricing/mix and service-provider LTE demand persist, and whether government-sector weakness continues.
- Cash conversion and liquidity after acquisitions, debt repayment and share repurchases; confirm the status and availability of the revolving credit facility and covenant compliance.
- Integration results from Accanto and ONPATH, including acquired revenue, costs, goodwill and intangible-asset impairment assumptions.
- Developments in the Accanto employee claims and California antitrust investigation, including any changes to accrued liabilities.
- Actual tax-rate effects, including the expected R&D credit benefit, and the impact of share-based compensation and other exclusions in management’s non-GAAP measures.