Reaffirms FY '23 Guidance After Slight Beat in Q1

NetScout Systems (NTCT) reported fiscal Q1 ’23 results slightly ahead of our estimates and consensus. Revenue increased 10% Y/Y as robust growth in the service provider vertical more than offset a decline in enterprise sales. Both AT&T and Verizon comprised over 10% of revenue in the quarter, resulting in service provider growth of 27% Y/Y. Enterprise sales were down 5% Y/Y, which management attributed to the timing of orders. Importantly, NetScout has yet to see any impact on its pipeline or business despite the recessionary talk of late. Also worth noting, Product sales rose 20% Y/Y as NetScout began executing against a robust backlog of RF Propagation Modeling projects secured in the latter half of FY ’22. Although down sequentially, NetScout entered Q2 with $85 million in product backlog, providing solid near-term visibility amid uncertain macroeconomic conditions. Gross margin was consistent with our assumptions, while operating expenses were just a shade higher as spending on in-person marketing events and travel began to normalize. As a result, both adjusted EBITDA and non-GAAP EPS beat our expectations.

For Q2, management anticipates a mid-single digit increase in both revenue and non-GAAP EPS, suggesting Street expectations were appropriately modeled heading into the print. Between NetScout’s existing backlog and commentary that several opportunities with the federal government have already been funded, we potential for another upside surprise on the horizon. For the full year, management reaffirmed its prior guidance. Our estimates remain intact for FY ’23 and tick up nominally for FY ’24.

With NetScout’s core service provider customers ramping up deployments of their 5G networks, we believe the company is in the early stages of a secular growth cycle and will be insulated from broader economic uncertainty to a degree. Moreover, NetScout’s expanded cybersecurity portfolio also provides new vectors for growth, particularly among its enterprise customers. Given the combination of solid near-term visibility and strong tailwinds for growth, we see further upside for NTCT shares. Our price target remains $38.00, representing an unchanged FY ’23 EV/EBITDA multiple of approximately 12x.

Exhibit I: Quarter Results and Guidance Versus Expectations

Sources: FactSet Estimates; K. Liu & Company LLC; NetScout Earnings Release

Q1 revenue of $208.8 million (+9.7% Y/Y) was above our estimate of $205.8 million and consensus of $204.8 million. Relative to our model, the upside was attributable to Product sales of $98.3 million (+19.9% Y/Y), which exceeded our estimate of $95.0 million. Service revenue of $110.6 million (+2.1% Y/Y) was approximately in line with our $110.8 million projection. The strong growth in Product sales benefited in part from $15 million in RF Propagation Modeling projects that were awarded in FY ‘22. With the calibration projects commencing, the associated backlog declined from $60 million last quarter to $45 million entering Q2. In addition, another $40 million in orders were booked late in the quarter and not shipped, bringing total product backlog to $85 million. As we have stated previously, NetScout’s backlog provides enhanced visibility into management’s guidance. By vertical, service provider comprised 53% of revenue and grew 27% Y/Y, while enterprise comprised the remaining 47% of revenue and decreased 5% Y/Y. Service Assurance solutions accounted for 72% of revenue in Q2, representing an increase of 11% Y/Y, and Security solutions accounted for the remaining 28% of revenue, reflecting growth of 7% Y/Y.

Non-GAAP gross margin of 74.5% was modestly above our 74.3% assumption. Product gross margin of 75.4% was slightly below our 76.0% estimate due to the higher mix of calibration revenue in the quarter, while Service gross margin of 73.6% was ahead of our 72.9% estimate. Operating expenses were marginally above our expectations, primarily due to higher sales and marketing expenses. Both non-GAAP operating income of $24.5 million (11.7% margin) and adjusted EBITDA of $29.8 million (14.3% margin) exceeded our estimates of $23.0 million and $28.5 million, respectively. Non-GAAP EPS of $0.24 also beat our estimate and consensus of $0.22.

Cash and investments at quarter-end totaled $374.6 million, while outstanding debt declined from $350.0 million to $200.0 million. As previously announced, NetScout also entered into an accelerated share repurchase agreement to buyback $150.0 million in stock.

Turning to guidance, management expects Q2 revenue and non-GAAP EPS to increase in the mid-single digit range, implying $220.4-$224.6 million and $0.49-$0.50, respectively. Prior to revisions, we were projecting revenue and non-GAAP EPS of $222.5 million and $0.51, respectively, while consensus stood at $222.5 million and $0.48. For FY ’23, management reaffirmed its prior guidance for revenue of $895.0-$925.0 million and non-GAAP EPS of $1.97-$2.03.

Exhibit II: Estimate Revisions

Source: K. Liu & Company LLC

Our estimates remain relatively unchanged for FY ‘23. For FY ’24, our projections move up ever so slightly on an uptick in our revenue forecast.

Our report with model and disclosures is available here.

Disclosure(s):

The analyst, a member of the analyst’s household, and/or an account in which the analyst exercises discretion hold(s) a long position in the common stock of NetScout Systems (NTCT).