Budget Flushes Fuel Stellar Q3 '25 Results

NetScout’s fiscal Q3 ’25 results crushed expectations as several large deals expected to close this quarter were pulled forward by customers utilizing their calendar year-end budgets. Most notably, NetScout secured a high-teens, eight-figure order from an existing Tier-1 North American service provider customer to support the expansion of their 5G network capacity. The company also saw strong demand from both service providers and enterprises for its cybersecurity solutions as evidenced by revenues from those products growing 29% Y/Y. Between the robust volume growth and favorable mix of cybersecurity sales, product gross margin reached the highest level ever that we can recall. This in turn resulted in both non-GAAP operating income and EPS easily exceeding our estimates and consensus.

With only one quarter remaining in the fiscal year, management narrowed its FY ’25 revenue and non-GAAP EPS guidance ranges while maintaining the prior midpoints. We note that the low-end of the revised revenue guidance sits above both the Street’s and our prior estimate for the year, and in contrast to last quarter, looks readily achievable after the stellar Q3 performance. Turning to the bottom line, while guidance appears largely unchanged on the surface, NetScout absorbed another $0.07 loss related to a foreign investment in Q3, so we surmise core operating earnings are moving higher to offset that.

We raise our estimates slightly for this year and next, primarily reflecting an uptick in service revenue and a reduction in interest expenses given management’s plans to fully repay its outstanding debt this quarter. We also introduce our FY ’27 projections, which reflect an acceleration in top line growth to the mid-single digits along with 100bps of operating margin expansion. Although quarterly results may remain lumpy for the foreseeable future, we are cautiously optimistic that the opportunities pulled into Q3 coupled with the positive results and commentary from the Tier-1 carriers in North America of late signal a new cycle of investments in 5G. Together with continued momentum in cybersecurity sales, we believe NetScout is poised to enter a period of renewed top line growth and margin expansion on an annual basis, which in turn should help close to valuation gap versus peers. Our price target increases from $38.00 to $41.00 based on a FY ’26 EV/EBITDA multiple of 12x. We note that our prior target was derived from the same multiple applied to our FY ’25 estimates.

Exhibit I: Quarterly Results and Guidance Versus Expectations

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

Q3 revenue of $252.0 million (+15.6% Y/Y) surpassed our estimate of $220.5 million and consensus of $221.4 million. Both product sales of $128.2 million (+33.7% Y/Y) and service revenue of $123.8 million (+1.3% Y/Y) exceeded our estimates of $105.0 million and $115.5 million, respectively. By product, revenue from service assurance solutions comprised 65% of revenue and increased 9% Y/Y, while cybersecurity sales comprised the remaining 35% of sales and increased 29% Y/Y. By vertical, revenue from service providers comprised 42% of total revenue in Q3 and increased 8% Y/Y, while enterprise customers accounted for 58% of revenue with a corresponding 22% Y/Y increase in revenue.

Non-GAAP gross margin of 82.8% was well above our 79.9% assumption. Both product and service gross margins were higher than we modeled. However, non-GAAP product gross margin of 88.2% was especially strong as NetScout benefited from both higher volumes and a favorable mix of cybersecurity sales. Over time, we suspect product gross margins at or above these levels will increasingly be the norm as service assurance solutions related to 5G deployments are largely software-only and as sales of cybersecurity solutions continue to comprise a higher mix of revenue. Total operating expenses were above our forecast, which we attribute to the timing of deal closures and the corresponding impact on incentive compensation. Regardless, the strong revenue and gross margin performance resulted in both non-GAAP operating income of $89.7 million (35.6% margin) and adjusted EBITDA of $92.8 million (36.8% margin) far exceeding our estimates of $65.7 million and $69.2 million, respectively. Non-GAAP EPS of $0.94 also crushed our estimate of $0.74 and consensus of $0.72 despite a $0.07 loss per share on a foreign investment.

Cash and investments at quarter-end totaled $427.9 million, while debt outstanding remained unchanged from the prior quarter at $75.0 million. We note that NetScout plans to repay the remaining $75.0 million in debt this quarter. In Q3, NetScout generated $41.5 million in cash flow from operations and used $1.9 million for capital expenditures.

With only one quarter remaining, management narrowed its FY ’25 guidance ranges for revenue and non-GAAP EPS while maintaining the prior midpoints. Due to the pull forward of deals into Q3, the revised outlook implies Q4 results below prior Street expectations. More importantly, achieving the midpoints of guidance for FY ‘25 now appears far more likely given the upside in Q3.

Exhibit II: Estimate Revisions

Source: K. Liu & Company LLC

We raise our estimates slightly for this year and next, primarily reflecting higher service revenue. We note that our FY ’26 EPS estimate increases more meaningfully due to a reduction in interest expenses associated with the company’s plan to pay down debt. We also introduce our FY ’27 estimates, which call for revenue of $868.8 million (+3.9% Y/Y) and non-GAAP EPS of $2.48.

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).