NetScout Systems, Inc. (NASDAQ:NTCT) Q1 2023 Earnings Conference Call August 4, 2022 8:30 AM ET
Company Participants
Tony Piazza – VP, Corporate Finance
Anil Singhal – President and CEO
Michael Szabados – COO
Jean Bua – EVP and CFO
Conference Call Participants
Dan Bergstrom – RBC
James Fish – Piper Sandler
Kevin Liu – K. Liu & Co.
Operator
Ladies and gentlemen, thank you for standing by, and welcome to NetScout’s First Quarter Fiscal Year 2023 Financial Results Conference Call. [Operator Instructions] As a reminder, this call is being recorded. Tony Piazza, Senior Vice President of Corporate Finance and his colleagues at NetScout are on the line with us today.
[Operator Instructions] I would now like to turn the call over to Tony Piazza to begin the company’s prepared remarks.
Tony Piazza
Thank you, operator, and good morning, everyone. Welcome to NetScout’s First Quarter Fiscal Year 2023 Conference Call for the period ended June 30, 2022. Joining me today are Anil Singhal, NetScout’s President and Chief Executive Officer; Michael Szabados, NetScout’s Chief Operating Officer; and Jean Bua, NetScout’s Executive Vice President and Chief Financial Officer.
There is a slide presentation that accompanies our prepared remarks. You can advance the slides in the webcast viewer to follow our commentary. Both the slides and the prepared remarks can be accessed in multiple areas within the Investor Relations section of our website at www.netscout.com, including the IR landing page under Financial Results, the webcast itself and under Financial Information on the quarterly results page.
Moving on to Slide 3. Today’s conference call will include forward-looking statements. Examples of forward-looking statements include statements regarding our future financial performance or position, results of operations, business strategy, plans and objectives of management for future operations and other statements that are not historical facts. You can identify forward-looking statements by their use of forward-looking words such as anticipate, believe, plan, will, should, expect, or other comparable terms. We caution listeners not to place undue reliance on any forward-looking statements included in this presentation, which speak only as of today’s date. These forward-looking statements involve risks and uncertainties, and actual results could differ materially from the forward-looking statements due to known and unknown risks, uncertainties, assumptions and other factors, including, but not limited to, those described on this slide and in today’s financial results press release.
For a more detailed description of the risk factors associated with the company, please refer to the company’s annual report on Form 10-K for the fiscal year ended March 31, 2022, on file with the Securities and Exchange Commission. NetScout assumes no obligation to update any forward-looking information contained in this communication or with respect to the announcements described herein.
Let’s now turn to Slide 4 which involves non-GAAP metrics. While this slide presentation includes both GAAP and non-GAAP results, unless otherwise stated, financial information discussed on today’s conference call will be on a non-GAAP basis only. The rationale for providing non-GAAP measures along with the limitations of relying solely on those measures is detailed on this slide and in today’s press release. These measures should not be considered in isolation from or as a substitute for financial information prepared in accordance with GAAP. Reconciliations of all non-GAAP metrics with the applicable GAAP measures are provided in the appendix of the slide presentation in today’s earnings, press release and on our website.
I will now turn the call over to Anil for his prepared remarks. Anil?
Anil Singhal
Thank you, Tony, and good morning, everyone. Welcome, and thank you all for joining us today. Let’s turn to Slide 6 for a brief recap of our non-GAAP financial results for the first quarter of our fiscal year 2023.
In the first quarter we achieved a strong top and bottom line performance, extending our business momentum from our last fiscal year into our current fiscal year 2023. Revenue was $208.8 million, representing year-over-year growth of nearly 10%. Our strong revenue expansion was driven approximately — by approximately 20% product revenue growth and approximately 2% service revenue growth, both on a year-over-year basis.
During the first quarter, our service assurance revenue grew by approximately 11%, while our security revenue grew by approximately 7%, both on a year-over-year basis. As a result, we grew our diluted EPS by approximately 20% year-over-year to deliver $0.24 per diluted share in the period.
Now let’s move to Slide 7 for some further perspective on market and business insights. On the security front, our new Omnis solution suite continue to gain recognition and traction in the marketplace as we further expanded its offering. For example, we recently launched the Omnis ATLAS Intelligence Feed for smarter automated DDoS attack blocking. As a new innovative AI-based solution, our Omnis AIF is continuously updated and enables the instantaneous blocking of a large portion of DDoS attacks, thus simplifying operations and minimizing risk for our customers’ businesses.
In recognition of our ongoing cybersecurity focus, we recently received the Cyber Defense Magazine Global InfoSec Award and for Market Leader in Network Detection and Response as well as the Fortress Cybersecurity Award in the Threat Detection category.
Although the total contribution from our new Omnis solutions within our security portfolio remains small relative to our overall revenue, this solution suite continues to show solid potential, and we are seeing our customers’ network and security teams beginning to understand the value of a shared visibility platform.
Now let’s turn to our customer verticals for more business insights, starting with our service providers. Service provider revenue in the first quarter grew approximately 27% year-over-year, primarily driven by radio frequency propagation modeling related revenues. We continue to see carriers invest in their 5G deployments, as evidenced by the number of radio frequency propagation modeling projects we are working on. During the first quarter, we also received additional 5G-related orders from both Tier 1 domestic and international carriers.
Moving to our enterprise customer vertical. Revenue declined by approximately 5% year-over-year in the first quarter of our fiscal year 2023. This decline was primarily due to the timing of enterprise customer order shipments. We remain confident in the health of this customer vertical despite the fluctuations in the near term. Enterprises continue to demand best-in-class cybersecurity solution as well as those solutions that can help facilitate the acceleration of their digital transformation. Michael will provide more insight regarding customer orders in our verticals during his remarks.
Now let’s move to Slide 8 to review our outlook. Looking ahead, we remain excited about the market opportunity we are seeing for both our existing and new solutions. From both a financial and a business perspective, we remain confident in our underlying fundamentals and positioning despite the persistence of various macro headwinds. As such, we are reiterating our non-GAAP outlook for our full fiscal year 2023. Jean will provide additional color and a recap of the numbers in her remarks.
In summary, our first quarter performance has extended our momentum into the new fiscal year, while also providing us with a solid foundation going forward. Additionally, we remain encouraged by our ability to help customers address the challenges and opportunities of today’s digital world effectively through our unique solutions. We look forward to sharing our progress with everyone throughout the remainder of our fiscal year.
With that, I’ll turn the call over to Michael.
Michael Szabados
Thank you, Anil, and good morning, everyone. Slide 10 outlines the areas I will be covering today, starting with customer wins. In our service provider customer vertical, we continued to see 5G-related activity, both in domestic and international markets. For example, during the first quarter, we received mid-7-figure orders with 5G-related elements from a Tier 1 domestic carrier and an international carrier as they continued to advance their 5G network deployment. Notably, these were follow-on orders as both carriers had placed 5G-related orders with us in the past.
Now turning to our enterprise customer vertical. In the first quarter, we secured a low seven-figure deal with a law enforcement agency of a large U.S. city for a combination of our service assurance and security solutions. In order to win this deal, we collaborated with the customers’ network and security operations teams who consequently judged and evaluated our solutions.
The requirements for more comprehensive insights and a scalable deep packet inspection solution to meet visibility and security needs, the customers’ teams determined that our solutions were ideal, particularly when compared to a competitor solution that was unable to fulfill the customers’ requirements.
Our deployment for this customer utilizes the ISNG data source for service assurance analytics provided by our nGeniusONE stack as well as the network-based detection and response capabilities of our new Omnis Cyber Intelligence stack. We are excited by this deal particularly because it demonstrates our both network and security teams can leverage a scalable deep packet inspection technology to create a shared visibility platform, and we continue to see increasing customer interest in these types of use cases.
Now our go-to-market activities. Now turning to our go-to-market activities. Importantly, we have continued to prioritize attending in-person events. We find these gathering both effective and efficient, allowing us to demonstrate our solutions and engage with existing and prospective customers.
For our second fiscal quarter, we plan to attend the Black Hat conference, which takes place in Las Vegas and caters to the cybersecurity community. We also plan to attend VMware Explore formerly known as VMworld, which takes place in San Francisco and is focused on enterprise digital transformation as well as cyber security.
At these events, we will demonstrate how NetScout and our customers are extending our visibility platform and underlying deep packet inspection technology into adjacent areas ranging from cybersecurity to adaptive DDoS. We will also showcase how our solutions are incorporating our Omnis AIF Intelligence Feed, solving remote work service assurance challenges and enhancing AI/Ops, analytics and more.
As Anil mentioned, while our new cybersecurity solutions are already starting to receive recognition, our existing solution in both security and service assurance are also generating further awareness. For example, in June, Forrester published its Total Economic Impact study on Omnis AED. Commissioned by NetScout, this report showed an impressive ROI of 201% over 3 years, effectively paying back the solutions cost in just 7 months. We also were recently awarded the Digital Innovator Award in the Enterprise Digital Transformation from Intellyx, an analyst and advisory firm for our enterprise service assurance solutions.
With that, I’ll conclude my prepared remarks for today. Thank you, everyone. I will now turn the call over to Jean.
Jean Bua
Thank you, Michael, and good morning, everyone. I will review key metrics for our first quarter of fiscal year 2023 and provide some additional commentary on our fiscal year 2023 outlook. As a reminder, this review focuses on our non-GAAP results unless otherwise stated, and all reconciliations with our GAAP results appear in the presentation appendix. Regardless, I will note the nature of any such comparisons.
Slide 12 details our first quarter fiscal year 2023 results. During the quarter, total revenue grew 9.7% year-over-year to $208.8 million. Product revenue grew 19.9% and service revenue grew 2.1%, both on a year-over-year basis.
Our first quarter fiscal year 2023 gross profit margin was 74.5%, up 0.3 percentage points over the same quarter last year. Quarterly gross margin was impacted by the addition of approximately $15 million in radio frequency propagation modeling projects, which had an average gross margin of less than 30%. Quarterly operating expenses increased 9.7% year-over-year, primarily attributable to the return to a pre-pandemic environment, including more in-person sales and marketing events as well as increased travel costs.
We reported an operating profit margin of 11.7% compared with 11.4% in the same quarter last year. Diluted earnings per share was $0.24 compared with $0.20 in the same quarter last year, an increase of 20% year-over-year.
Turning to Slide 13. I’d now like to review key revenue trends by customer verticals and product lines. For the first quarter of fiscal year 2023, on a year-over-year basis, our service provider customer vertical revenue grew 26.9% while our enterprise customer vertical revenue declined 4.8%. During the quarter, our service provider customer vertical accounted for 53% of our total revenue, while our enterprise customer vertical accounted for the remaining 47%.
Now turning to our product lines. In the first quarter of fiscal year 2023, our service assurance revenue increased by 11% year-over-year, while our security revenue increased by 6.7% year-over-year. During the first quarter, the service assurance product line represented approximately 72% of total revenue, while our security product line represented the remaining 28%.
Turning to Slide 14, which shows our geographic revenue mix. In the first quarter, our revenue was more concentrated than usual in the U.S. due to increased Tier 1 domestic carrier radio frequency propagation modeling project revenue. Also, 2 customers represented 10% or more of our total revenue in the quarter.
Slide 15 details our balance sheet highlights and free cash flow. We ended the quarter with $374.6 million in cash, cash equivalents and short and long-term marketable securities, representing a decrease of $328.6 million since the end of fiscal year 2022. The decrease was primarily attributable to the 2 capital structure transactions we initiated in the first quarter of fiscal year 2023.
The first transaction was a repayment of $150 million of debt on our revolving credit facility, while the second transaction was the execution of an accelerated share repurchase agreement to repurchase up to $150 million of our common stock. Through the accelerated share repurchase transaction, we received 70% of the estimated program shares upfront or approximately 3.3 million shares. We anticipate receiving the remaining 30% when the program concludes, no later than the end of the third quarter of our fiscal year 2023.
Free cash flow for the quarter was negative $14.9 million. From a debt perspective, we ended the first quarter of fiscal year 2023 with $200 million outstanding on our $800 million revolving credit facility, which expires in July 2026.
To briefly recap our other balance sheet highlights, accounts receivable net was $112.9 million, a decrease of $35.3 million since March 31, 2022. The DSO metric at the end of the first quarter of fiscal year 2023 was 44 days versus 63 days at the end of the first quarter of fiscal year 2022 and 64 days at the end of our fiscal year 2022.
Let’s move to Slide 16 for commentary on our outlook. I will focus my review on our non-GAAP targets for fiscal year 2023. As Anil noted earlier, we are reiterating our non-GAAP outlook for fiscal year 2023 that was presented during our May 5, 2022, fourth quarter and full fiscal year earnings call.
As a reminder, for fiscal year 2023, we anticipate revenue in the range of $895 million to $925 million, which implies a mid-to-high single-digit top line growth rate. The effective tax rate is anticipated to be in the range of 20% to 22%, with the current rate at the upper end of that range.
Assuming between 73 million and 74 million weighted average diluted shares outstanding, which includes the estimated impact of the $150 million accelerated share repurchase program with a partial offset for stock compensation dilution, we expect our non-GAAP diluted earnings per share to be between $1.97 and $2.03.
I’d also like to offer some color on the second quarter. As we assess the opportunities in front of us, we currently anticipate mid-single-digit revenue and EPS growth rate on a year-over-year basis.
That concludes my formal review of our financial results. Thank you, and I will now turn the call over to the operator for Q&A.
Question-and-Answer Session
Operator
[Operator Instructions]. We’ll take our first question from Matt Hedberg with RBC.
Dan Bergstrom
It’s Dan Bergstrom for Matt Hedberg. So good start to the year here, reiterating guidance for the year, nice to see. Maybe with a lot going on, could you talk to some of the confidence points you have around guidance for the year? And then on the enterprise side, could you drill down there a bit? Did you notice any changes in buying patterns, any additional scrutiny around deals there, maybe expanding upon Anil’s statement where he called out some timing of enterprise customer order shipments?
Anil Singhal
So Matt, overall, I mean, I know there are a lot of anxiety about recession and what’s going on. So far luckily, we are not seeing the impact on that, on our pipeline or our business. Enterprise business was very strong last year and some pull forward deals and all those.
So I think this is just a timing and I think our quarterly results versus the yearly gets skewed because of large deals. So at this point, we are not seeing any impact really on — from what is the macro headwinds. And as we see — I mean, we still feel good about the guidance range we have provided.
Dan Bergstrom
Great. Helpful. And then with security, Jean, thank you for that historical breakout. Nice to see something we’re looking for. Just that said, just on the seasonality here, it looks like your third quarter, the December calendar year quarter was seasonally strongest last year. Is that the type of cadence we should look for on security here, kind of that normal enterprise build through the year with the segment? Or is there anything else to keep in mind around enterprise seasonality out for security?
Jean Bua
Yes. As you pointed out, Dan, the second half of our year, either Q3 or Q4 is seasonally higher due to the timing of the calendar year budget companies. The only thing I would say is, as the year progresses, and we continue to see traction in Omnis, you might be able to see a little more of an impact in Q4 than in Q3.
Operator
Our next question comes from James Fish with Piper Sandler.
James Fish
Jean, deferred revenue was down a bit more than normal this quarter. It looks like by about $40 million sequentially. Was this related to product backlog or something else? In the last few quarters, you actually gave us product backlog. Could you give us that this quarter, including across, I think you broke out core and radio frequency parts in the past?
Jean Bua
Sure. So deferred revenue is a function of 2 things. One, as you mentioned, the use of the calibration project revenue, the radio frequency propagation modeling that we started to execute on in this fiscal year as well as generally just the timing of multiyear renewal orders, where we’re very heavy in Q3 and Q4 and much lighter in Q1.
The product backlog, as you recollect, was about $110 million at the end of last fiscal year with about $60 million of that being calibration. So we used approximately $15 million this year — this quarter, I’m sorry. And so of that, we would have about $45 million left of calibration revenue to go through the product revenue line item. The shippable backlog, which goes through product revenue also we shipped the $50 million at the beginning of Q1, and then we built the backlog in that area back up to about $40 million. So total backlog at the end of Q1 still sits around $85 million.
James Fish
Great. I appreciate that. And I also appreciate that security versus service assurance. So I won’t bug you on that question like I normally do, Jean.
Jean Bua
Thank you.
James Fish
On the radio frequency side, a great quarter there, but how much longer of a tail do you guys expect the RFP business to have versus we’re starting to hear some of the core service assurance deployments? And is there any way to think about how you guys are getting the kind of gross margin on the year given the mix between RFP and the core service assurance?
Anil Singhal
Well, as we move more and more toward software side, I mean, we can compensate for some of the lower gross margins on calibration and service revenue. So overall, as our business goes, I mean we see top line growth and our OpEx line is generally similar to the previous year, except for the travel expenses we talked about, we said this will be balanced out. And when we gave the guidance on EPS and everything, it assumes most of the calibration or all of it, I guess, Jean, to be shipped this year. So that’s all built into the numbers which we have provided for the guidance.
Jean Bua
Yes. And just to add to that point, Jim, gross profit, you’re correct, we’ll be absorbing about $60 million of backlog at probably less than 40% margin. So I think we anticipate that our gross margin this year on a year-over-year basis will be relatively flat to potentially slightly up from the full gross profit margin of last year.
Operator
Our final question comes from Kevin Liu with K. Liu & Company.
Kevin Liu
Could you talk a little bit about this — what the government pipeline looks for this quarter? And if you would kind of expect the normal seasonal strength how you tend to see?
Jean Bua
Sure. So this quarter, as you know, Q2 is the 9/30 government year. Again, we have excellent relationships with government. The good news this year is that most of the projects that we have in our Q2 forecast have been funded. Usually, we have a lot of projects, and some of them are funded are not funded. I would say on a year-over-year basis, given just the state of the U.S. government at this point in purchasing and their focus, I would think that our Q2 revenue will probably be similar to the Q2 of last year and maybe up from that percentage.
Kevin Liu
And then just in terms of the second half outlook for service provider spending, it seems like many of the large Tier 1s domestically at least have invested more heavily in the front half of the year. Just wondering how you guys think the second half progresses in terms of service provider mix and whether you’ll continue to see more kind of work on the propagation modeling side or if that starts to change either to more traditional assurance or security deployments?
Anil Singhal
I think it’s going to be more — it’s going to be much less calibration and mostly service assurance orders and business in the second half. And this quarter’s year-over-year growth was driven somewhat by the backlog. So we still have a lot of business in the pipeline with the service provider. And I think that enterprise look depressed but overall, when we end the year, will be — it will be in line with very similar breakdown between service provider and enterprise tomorrow.
And yes, I think so basically, there is — besides calibration and traditional service assurance, there are some other things happening with — people are getting the 5G spectrum, which is the RAN area. So calibration is one of the bookends, very, very low margin. And then we have service assurance, which is the other book and but in between, we have the RAN business. So as people are getting more 5G spectrum like anything in the — I mean, in India and other places, we see some much better business in the RAN area, which has very similar margin profile as a general service assurance business versus last year.
Operator
There are no further questions at this time. I’ll turn the call over to Tony for closing remarks.
Tony Piazza
Thank you, operator. Thank you, everybody, for joining us today. That concludes our call for the day. Have a good day. Thank you. Bye.
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