Reports Solid Q1 Results and Reaffirms Full Year Guidance
NetScout Systems (NTCT) reported Q1 results slightly ahead of our estimates and consensus. Relative to our model, the revenue upside was wholly attributable to higher service revenue, which benefited in part from some catch-up in maintenance. Product revenue was in line with our estimate but reflected a more favorable sales mix, which in turn drove gross margin well above our assumption. In this regard, we were encouraged to see double-digit growth in sales of NetScout’s security products, and we believe the relaunch of the company’s Omnis Cyber Intelligence solution along with the recent expansion of its DDoS portfolio to include Adaptive DDoS and Mobile Security could further accelerate growth moving forward. As expected, revenue from service assurance products declined slightly due to the completion of several significant RF Propagation Modeling (RFPM) projects over the past year. Below the revenue line, the strong gross margin performance more than offset higher sales and marketing expenses than we projected, resulting in both adjusted EBITDA and non-GAAP EPS outpacing our expectations.
Similar to other network-centric vendors, NetScout’s backlog of fulfillable orders at quarter-end began to normalize and is now closer to historical norms. We surmise that the negative reaction in the stock price post-earnings was largely attributable to the sequential drop in backlog, which perhaps raised concerns about the demand environment and near-term visibility. From our perspective, the normalization of backlog has been anticipated for at least a couple of quarters now, and management’s implied outlook for Q2 should assuage any immediate concerns over the demand environment. In addition to reaffirming its prior FY ’24 guidance, the expected contribution from 1H results suggests revenue and non-GAAP EPS in Q2 should come in slightly above Street expectations heading into the print. That management anticipates the usual seasonal ramp this quarter despite having less backlog to rely on signals healthy activity in the pipeline and visibility into the timing of larger deal closures, in our opinion.
Aside from some fine-tuning between line items, our estimates for this year and next remain intact. Our price target also remains unchanged at $42.00 based on a FY ‘24 EV/EBITDA multiple of approximately 12x. We believe NetScout’s solid execution amid a challenging environment remains underappreciated, and we continue to see significant upside in the stock given the company’s long runway for growth as service providers scale new 5G offerings and its expanded suite of cybersecurity solutions gains traction.
Exhibit I: Quarterly Results and Guidance Versus Expectations
Sources: FactSet Estimates; K. Liu & Company LLC; NetScout Earnings Release
Q1 revenue of $211.1 million (+1.1% Y/Y) was slightly above our estimate of $209.2 million and consensus of $207.9 million. Product sales of $94.7 million (-3.7% Y/Y) were in line with our $95.0 million estimate, while service revenue of $116.5 million (+5.4% Y/Y) was ahead of our $114.2 million projection. Revenue from service assurance products comprised 69% of revenue and declined 2% Y/Y, while cybersecurity sales made up the remaining 31% of sales and increased 10% Y/Y. The decline in service assurance revenue reflects the completion of several large RFPM projects over the past year and coincides with a 9% Y/Y decline in revenue from the service provider vertical, which accounted for 48% of total revenue in Q1. However, these declines were more than offset by strong growth in security products across both the service provider and enterprise verticals, the latter of which comprised the remaining 52% of revenue and grew 13% Y/Y. Backlog at quarter-end was $16 million, down from $44 million in the prior quarter as customer order patterns continue to normalize amid easing supply chain constraints. Per management, NetScout has historically averaged $10-$15 million in backlog, including periods when backlog was at only nominal levels. We had expected backlog to begin normalizing coming into the fiscal year, so the sequential decline was not particularly surprising.
Non-GAAP gross margin of 78.3% was well above our 75.4% assumption as both product and services margins exceeded our expectations. Non-GAAP product gross margin of 84.5% easily exceeded our 80.0% estimate due to a favorable sales mix, while service gross margin of 73.2% was ahead of our 71.5% estimate due to the combined impact of higher revenue and lower costs. Total operating expenses ran higher than our projections, primarily due to higher sales and marketing expenses. Regardless, both non-GAAP operating income of $29.6 million (14.0% margin) and adjusted EBITDA of $34.6 million (16.4% margin) beat our estimates of $27.7 million and $33.1 million, respectively. Non-GAAP EPS of $0.31 also beat our estimate and consensus by a penny.
Cash and investments at quarter-end totaled $390.5 million, while outstanding debt remained unchanged at $100.0 million. In Q1, NetScout used $22.3 million in cash for operations and had $2.0 million in capital expenditures.
Looking forward, management reaffirmed its prior guidance for FY ’24, which calls for revenue of $915.0-$945.0 million and non-GAAP EPS of $2.20-$2.32. Management also reiterated its prior expectations for revenue in 1H ’24 to comprise 46%-48% of revenue for the year and non-GAAP EPS to grow at a mid-single digit rate. Assuming the midpoint of management’s FY ’24 revenue guidance, this implies Q2 revenue of $216.7-$235.3 million and non-GAAP EPS of $0.53-$0.55, both of which compared favorably with our prior estimates and consensus.
Exhibit II: Estimate Revisions
Source: K. Liu & Company LLC
We made only minor adjustments to our model, including some fine-tuning in the revenue mix, a modest uptick in our gross margin assumptions and slightly higher operating expenses. Overall, our estimates for FY ’24 and FY ’25 remain relatively unchanged.
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).