Service Provider Slowdown Weighs on Q4 Results and Outlook for FY ‘25

NetScout Systems (NTCT) reported fiscal Q4 ‘24 results below our estimates and consensus due to a pause in spending by Tier 1 service providers in the U.S. Worth noting, the slowdown in spending by service providers masked another quarter of robust growth for NetScout’s cybersecurity solutions, which in turn boosted product gross margin slightly above our assumption. Operating expenses also compared favorably with our projection, primarily due to lower selling and marketing expenses. However, both non-GAAP operating income and adjusted EBITDA were below our estimates and consensus due to the revenue shortfall. Although non-GAAP EPS beat expectations, the upside was wholly attributable to higher other income and a lower tax rate than modeled.

Domestically, the large service providers have slowed their pace of 5G network deployments amid a more benign competitive environment and to ensure investments in new service offerings generate appropriate returns on capital. Management expects this backdrop to persist throughout FY ’25, presenting a headwind to growth for NetScout’s service assurance products. In contrast, ongoing geopolitical conflicts and a high-activity threat landscape should fuel further momentum for sales of cybersecurity solutions. With service assurance still representing the bulk of sales, however, management’s initial outlook for FY ’25 calls for a flat to down year in revenue. Given the anticipated top line performance, the company has also instituted a restructuring plan expected to generate significant savings beginning in Q2. All told, the cost reduction effort enabled management to guide FY ’25 non-GAAP EPS ahead of our estimate and consensus despite a lower revenue outlook.

Our adjusted EBITDA and non-GAAP EPS estimates remain intact on lower revenues for both FY ’25 and FY ’26. We also maintain our price target of $38.00 based on an unchanged FY ’25 EV/EBITDA multiple of approximately 12x. While we recognize that multiple expansion is likely to be constrained until sentiment around service provider spending improves, we continue to believe that new 5G-enabled offerings, including fixed wireless access and private networks, remain in the early innings and will ultimately drive a period of sustained demand for NetScout’s solutions. In the meantime, the company’s cybersecurity portfolio continues to gain traction, a dynamic we believe is underappreciated by the market. We also surmise that at current levels, NetScout could pique the interest of an acquirer. Interestingly, Spirent Communications (LSE: SPT), which previously acquired some non-core assets from NetScout, recently agreed to be acquired by Keysight Technologies (KEYS) for 2.8x TTM revenue and nearly 27x TTM EBITDA.

Exhibit I: Quarterly Results and Guidance Versus Expectations

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

Q4 revenue of $203.4 million (-2.2% Y/Y) fell short of our $215.9 million estimate and consensus of $214.9 million. Product and service revenues of $89.4 million (-2.0% Y/Y) and $114.0 million (-2.4% Y/Y), respectively, were below our estimates of $97.5 million and $118.4 million. The revenue shortfall was largely attributable to a domestic slowdown in service provider spending. Revenue from service assurance products comprised 65% of revenue and declined 11% Y/Y, reflecting reduced spending by Tier-1 service providers in the U.S., partially offset by an eight-figure, mid-teens deal with an existing international customer that represents the first of several opportunities to support their 5G network rollout. Cybersecurity sales comprised the remaining 35% of sales and increased 20% Y/Y as customers grappled with an active threat landscape. By vertical, service providers accounted for 51% of total revenue in Q4, while enterprise customers comprised the remaining 49% of revenue.

Non-GAAP gross margin of 77.2% was below our 78.9% assumption due to lower service gross margin than we modeled. We note that product gross margin of 84.2% was consistent with our 84.0% assumption and continues to reflect the favorable mix of cybersecurity sales. Total operating expenses were lower than we projected as higher R&D expenses were more than offset by lower SG&A expenses. However, this was not sufficient to offset the revenue shortfall and both non-GAAP operating income of $39.0 million (19.2% margin) and adjusted EBITDA of $42.9 million (21.1% margin) missed our estimates of $47.8 million and $52.2 million, respectively. Non-GAAP EPS of $0.55 exceeded our estimate and consensus of $0.53, but the upside was wholly attributable to higher other income and a lower tax rate.

Cash and investments at quarter-end totaled $424.1 million, while outstanding debt remained unchanged at $100.0 million. In Q4, NetScout generated $93.6 million in cash flow from operations and had $1.6 million in capital expenditures. The company did not repurchase any shares in Q4 but anticipates being active in Q1, subject to market conditions.

Management’s guidance for FY ’25 calls for revenue of $800.0-$830.0 million, reflecting a flat to down year as lower spending by service providers offsets anticipated growth in sales of cybersecurity solutions. Prior to revisions, we were projecting $848.5 million in revenue, while consensus stood at $839.7 million. In response to the current demand environment, management has initiated a voluntary separation program expected to generate savings of $18.0-$22.0 million on an annualized basis. As a result, management’s FY ’25 non-GAAP EPS guidance of $2.10-$2.30 compared favorably with our prior estimate of $2.08 and consensus of $2.13.

Exhibit II: Estimate Revisions

Source: K. Liu & Company LLC

We reduced our revenue estimates for this year and next to account for the slowdown in service provider spending. However, an increase in gross margin arising from a more favorable mix of cybersecurity sales coupled with anticipated savings from the company’s restructuring plan enabled us to maintain our prior adjusted EBITDA estimates for FY ’25 and FY ‘26.

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).