Business context and reporting period
NetScout Systems, Inc. provides service assurance and security solutions for service-provider and enterprise networks. This Form 10-Q covers the quarter and nine months ended December 31, 2020 (fiscal 2021 Q3), compared with the corresponding 2019 periods. The company reports one operating segment.
Financial performance and liquidity
Amounts below are in millions of dollars, except per-share data and percentages.
| Metric | Q3 FY2021 | Q3 FY2020 | Nine months FY2021 | Nine months FY2020 |
|---|---|---|---|---|
| Revenue | $228.7 | $260.0 | $617.9 | $662.5 |
| Gross profit / margin | $173.5 / 76% | $194.4 / 75% | $450.7 / 73% | $483.0 / 73% |
| Operating income | $31.8 | $36.8 | $21.1 | $5.1 |
| Net income (loss) | $29.0 | $36.7 | $7.9 | $(10.1) |
| Diluted EPS | $0.39 | $0.49 | $0.11 | $(0.13) |
- Q3 revenue declined 12% year over year; product revenue fell 20% to $115.0 million, while service revenue fell 3% to $113.8 million.
- For the nine months, revenue declined 7%. Product revenue decreased 13% to $278.6 million; service revenue was down less than 1% to $339.3 million.
- Nine-month operating cash flow was $121.9 million, versus $117.8 million in the prior-year period. Investing activities provided $24.2 million and financing activities used $17.0 million. Cash, cash equivalents and marketable securities increased to $490.4 million from $389.1 million at March 31, 2020.
- At December 31, cash and marketable securities were $490.4 million and long-term debt was $450.0 million. The company reported $245 million of incremental availability under its $1.0 billion revolving facility, based on covenant levels. It was in compliance with covenants.
- Current assets were $762.6 million and current liabilities were $396.2 million. Total deferred revenue and customer deposits were $354.0 million, including $251.3 million current.
- On January 29, 2021, NetScout repaid $100 million of revolver borrowings.
Changes versus prior comparable periods
- Management attributed lower revenue primarily to weaker network performance management sales in enterprise and service-provider markets; DDoS offerings partly offset the decline. Nine-month U.S. revenue fell 11%, while international revenue was approximately flat.
- Gross margin improved one percentage point in Q3 and was flat for the nine-month period. Q3 product gross margin rose to 79% from 76%; nine-month service gross margin declined to 72% from 74%.
- Nine-month GAAP net income improved by $18.0 million from the prior-year loss. Management cited lower travel, events, materials, amortization, commissions, inventory charges and advertising, partly offset by the $44.6 million revenue decline. Cost reductions included COVID-related spending restrictions and reduced hiring.
- Reported nine-month non-GAAP diluted EPS was $1.21 versus $1.07, and non-GAAP operating income was $125.0 million versus $114.6 million. These company-defined measures exclude specified items, including share-based compensation and acquired-intangible amortization; they are not substitutes for GAAP results.
Outlook, risks and unusual items
- Management said elongated purchasing cycles and the uncertain COVID-19 environment were expected to affect fiscal 2021 results. It stated a commitment to manage costs with the aim of improving GAAP EPS versus the same period last year, but provided no specific revenue or earnings forecast in the supplied filing text.
- Management expected operating cash flow, cash and investments, and revolver availability to fund obligations, capital spending, debt service and working capital for at least the next 12 months. It also said cash could be used for acquisitions, debt repayment or share repurchases.
- The Packet Intelligence patent case remains a material contingency. The appeals court vacated the $3.5 million pre-suit damages award, affirmed $2.25 million of post-suit damages, and remanded the question of enhancement. NetScout considered loss on post-suit damages probable; interest and royalties may also be payable, and a possible enhancement of $0–$2.8 million was not reasonably estimable.
- NetScout accrued penalties assessed by UK tax authorities concerning historical VAT application, and recorded amounts due to HMRC and receivables billed to affected customers; the filing does not provide a clear dollar amount for these balances. The penalty suspension period was scheduled to end March 10, 2021, subject to no further discrepancies.
- The company had deferred $8.9 million of employer payroll taxes under the CARES Act, with half due by December 2021 and the remainder by December 2022. Its floating-rate debt creates interest-rate exposure, and the credit agreement references LIBOR ahead of the benchmark’s planned phaseout. The filing identifies COVID-19 impacts, competition, customer purchasing behavior, foreign exchange and execution of cost controls as uncertainties.
Important facts for investors to verify
- Whether product demand—particularly network performance management in U.S. enterprise and service-provider markets—recovers, and whether DDoS growth can continue to offset weakness.
- Whether expense reductions are sustainable and translate into improved GAAP earnings without impairing sales, product development or service delivery.
- The final exposure in the Packet Intelligence matter, including enhancement, interest and post-trial royalties, and the outcome of the UK VAT penalty suspension.
- Debt repayment and covenant headroom after the January 2021 $100 million repayment, including the transition from LIBOR-based borrowing terms.
- Deferred revenue trends and customer collections; one direct customer represented more than 10% of accounts receivable at December 31, 2020, although no customer represented more than 10% of revenue.