Reports Solid Start to FY ‘25

NetScout Systems (NTCT) delivered solid fiscal Q1 ‘25 results, exceeding our estimates and consensus. Relative to our model, the upside was largely attributable to higher than anticipated product sales, which benefited from the extension of an eight-figure, multi-year enterprise license agreement with a Tier-1 service provider in North America. Although the extension itself was not necessarily a surprise, we surmise management had allowed for some leeway in the timing of the deal closure, hence the original expectations for a slower start to FY ’25. With gross margin running slightly ahead of our assumption and operating expenses on a non-GAAP basis only marginally higher, the upside on the top line largely flowed through to the bottom line. Additionally, an unrealized gain on an investment further boosted earnings, resulting in a significant non-GAAP EPS beat.

Given the solid start to the fiscal year, management reaffirmed its prior FY ’25 revenue and non-GAAP EPS guidance. From a seasonal perspective, management continues to expect revenue in 1H to approximate 45% of full year sales, resulting in expectations for Q2 coming in below our prior estimates and consensus. As noted above, we believe this primarily reflects the timing of the large service provider deal secured in Q1. Thus, the only change to prior expectations pertains to management’s GAAP EPS guidance, which was lowered due to a one-time, non-cash goodwill impairment charge incurred in Q1. Also worth mentioning, guidance for non-GAAP EPS was left unchanged as the foreign investment that provided an unrealized gain in Q1 is marked to market each quarter, creating the possibility for a reversal of fortunes in subsequent periods. Assuming no additional gains or losses, however, we believe the company is tracking towards the mid to high-end of its current non-GAAP EPS guidance range.

We raise our revenue and non-GAAP EPS estimates nominally for this year and next. With no material updates to our model, we maintain our price target of $38.00 based on an unchanged FY ’25 EV/EBITDA multiple of approximately 12x. Given the company’s Q1 performance and signs of stabilization in the service provider vertical, we believe NetScout remains on track for renewed revenue growth and margin expansion in the latter half of this year. Longer term, the company’s expanded portfolio of cybersecurity solutions and AIOps partnerships with the likes of Datadog, Palo Alto Networks, ServiceNow and others have the potential to drive a more meaningful acceleration in growth, in our opinion. In the interim, management remains focused on sustaining strong profitability and free cash flow, which we expect to be allocated towards additional repurchases, particularly with shares trading at less than 6x adjusted EBITDA on both a trailing and forward basis.

Exhibit I: Quarterly Results and Guidance Versus Expectations

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

Q1 revenue of $174.6 million (-17.3% Y/Y) exceeded our $169.9 million estimate and consensus of $168.5 million. Product revenues of $61.2 million (-35.4% Y/Y) were well above our estimate of $55.0 million, while service revenues of $113.4 million (-2.6% Y/Y) were just shy of our $115.0 million projection. Per management, growth in Q1 was negatively impacted by approximately $37 million in revenue that was recognized from backlog in the year-ago period, and revenue would have been flat on a normalized basis. Revenue from service assurance products comprised 67% of revenue and declined 20% Y/Y, while cybersecurity sales comprised the remaining 33% of sales and declined 11% Y/Y. Adjusting for the backlog dynamic last year, we believe service assurance revenue would have increased slightly and cybersecurity sales would have been down modestly. By vertical, revenue from service providers comprised 54% of total revenue in Q1, while enterprise customers accounted for the remaining 46%.

Non-GAAP gross margin of 77.1% was ahead of our 76.8% assumption as higher product gross margin more than offset lower service gross margin than we modeled. Total operating expenses were slightly above our estimate, mostly due to higher R&D expenses than we forecasted. Regardless, the upside in revenue and gross margin resulted in both non-GAAP operating income of $14.0 million (8.0% margin) and adjusted EBITDA of $17.8 million (10.2% margin) exceeding our estimates of $11.0 million and $14.9 million, respectively. Non-GAAP EPS of $0.28 beat our estimate of $0.13 by an even greater margin due to an unrealized gain on an investment of $0.10 per share that was not considered in our model.

Cash and investments at quarter-end totaled $407.2 million, while outstanding debt remained declined from $100.0 million to $75.0 million. In Q1, NetScout generated $38.5 million in cash flow from operations and had $1.3 million in capital expenditures. The company also repurchased approximately $25.0 million in stock at an average price of $18.55 per share.

Management reaffirmed its prior FY ’25 guidance for revenue of $800.0-$830.0 million and non-GAAP EPS of $2.10-$2.30. Due to the timing of the large service provider deal closed in Q1, expectations for Q2 revenue of $185.0-$195.0 million and non-GAAP EPS of $0.42-$0.51 were below our prior estimates of $197.6 million and $0.59, respectively.

Exhibit II: Estimate Revisions

Source: K. Liu & Company LLC

We raise our estimates slightly for this year, primarily reflecting the upside in Q1 partially offset by lower expectations for Q2. Our estimates for next year also move up nominally as we fine-tuned our assumptions. Overall, we continue to expect NetScout to reach an inflection point in growth and margin expansion during the latter half of this year.

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).