Reports Solid Start to FY '22
NetScout Systems (NTCT) reported Q1 ’22 results ahead of expectations. The upside was attributed to stronger than anticipated growth in Product sales, which benefited from spending on both service assurance and security solutions by domestic cable operators and the acceptance of a project implementation by an international carrier one quarter earlier than anticipated. The strength in Product sales also offset an unexpected decline in Service revenue, which was attributed to non-renewals by a domestic service provider post-consolidation as well as product discontinuations. By vertical, service provider growth was approximately 10% while enterprise declined approximately 1% due to reduced spending on security among NetScout’s financial services customers. Interestingly, management expressed optimism in both enterprise and security growth for the year, noting that growth in the company’s cybersecurity portfolio is expected to be nearly double the rate of growth for service assurance solutions. Below the revenue line, gross profit was a touch lower than we anticipated due to an inventory reserve taken for discontinued products and the decline in Services revenue. However, operating expenses were relatively consistent with our forecast, which combined with the revenue upside resulted in profitability ahead of management’s guidance and our estimates.
Near-term, management anticipates revenue growth of approximately 1.5% and non-GAAP EPS growth in the mid-single digit range in 1H ’22, implying Q2 revenue and non-GAAP EPS slightly below our prior estimates and the Street’s. The lower outlook for Q2 is fully attributable to the aforementioned pull-forward of revenue from an international carrier into Q1. For the full year, management reiterated its prior guidance for revenue and non-GAAP EPS. We note that guidance for EPS on a GAAP basis was lowered to account for charges taken to amend the company’s credit facility on more attractive terms, higher stock-based compensation costs arising from new performance-based restricted stock units and a slight increase in anticipated amortization expense.
Our revenue estimates for this year and next decline slightly given the lower run rate of Service revenue exiting Q1. While these reductions were partially offset by lower operating expense assumptions, our adjusted EBITDA and non-GAAP EPS estimates also decrease slightly. That said, the adjustments to our model are relatively minor, and we therefore maintain our price target of $33.00 based on an unchanged FY ’22 EV/EBITDA multiple of approximately 12x. We continue to believe NetScout is poised to benefit from the rollout of standalone 5G networks and innovation in its growing portfolio of security offerings.
Exhibit I: Quarterly Results and Guidance Versus Expectations
Q1 revenue of $190.3 million (+3.5% Y/Y) was above guidance for growth of 0%-2%, our estimate of $185.9 million and consensus of $186.2 million. Relative to our model, the upside was attributable to higher than anticipated Product sales of $82.0 million (+14.3% Y/Y), which exceeded our estimate of $72.5 million and more than offset lower Service revenue of $108.3 million (-3.4% Y/Y). We were projecting Service revenue of $113.4 million. By vertical, service provider comprised 46% of revenue and grew 10% Y/Y on strong adoption of both service assurance and security solutions. Enterprise comprised the remaining 54% of revenue and decreased 1% Y/Y as modest growth in service assurance sales was offset by a mid single-digit decline in security products. Worth noting, enterprise security sales faced a difficult comparison as the onset of the pandemic and corresponding shift in work environments prompted a wave of spending in the year-ago period. Management continues to expect growth in its security solutions to nearly double the rate of growth in its service assurance products this year.
Gross margin on a non-GAAP basis was 74.2%, down slightly from 74.6% last year and shy of our 75.0% assumption. Product gross margin of 76.2% was below our 78.0% assumption due to a combination of product mix and an inventory reserve taken for discontinued products. Of note, software-only sales comprised 32% of service assurance product revenue versus 40% last year. Service gross margin of 72.6% was short of our 73.1% estimate due to deleverage associated with the lower revenue base. Operating expenses were largely in line with our expectations as higher sales and marketing expenses were offset by lower research and development costs. Both non-GAAP operating income of $21.8 million (11.4% margin) and adjusted EBITDA of $27.6 million (14.5% margin) were ahead of our $19.5 million and $26.0 million estimates, respectively. Non-GAAP EPS of $0.20 beat guidance for $0.17-$0.19 and our estimate of $0.18.
In Q1, NetScout generated $24.1 million in free cash flow and exited the quarter with cash and investments of $493.9 million. Outstanding debt remained unchanged at $350.0 million. Looking forward, management expects revenue growth of approximately 1.5% in 1H ’22 and a corresponding mid-single digit increase in non-GAAP EPS. The outlook implies Q2 revenue and non-GAAP EPS of approximately $205.0 million and $0.38, respectively, which was slightly below both our estimates and consensus. We note that the variance for Q2 primarily reflects the pull-forward of a large international service provider deal into Q1. For the full year, management’s guidance for revenue of $835.0-$865.0 million and non-GAAP EPS of $1.71-$1.77 remains intact.
Exhibit II: Estimate Revisions
We lower our estimates slightly for this year and next, primarily reflecting lower Service revenue across our forecast horizon. As NetScout has secured another significant radio frequency propagation modeling project, we also reduced our gross margin assumptions slightly to account for the impact on product mix. Although lower operating expenses mitigated the impact on the bottom line to an extent, our adjusted EBITDA and non-GAAP EPS estimates also decline modestly.
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).