NetScout Systems (NTCT) Q3 2022 Earnings Call Transcript

NetScout Systems (NTCT 0.69%)
Q3 2022 Earnings Call
Jan 27, 2022, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to NetScout's third quarter fiscal year 2022 financial results conference call. At this time, all parties are in a listen-only mode until the Q&A session portion of the call. As a reminder, this call is being recorded. Tony Piazza, vice president of corporate finance, and his colleagues at NetScout are on line with us today.

[Operator instructions] I would now like to turn call over to Tony Piazza to begin the company's prepared remarks.

Tony Piazza -- Vice President of Corporate Finance

Thank you, operator, and good morning, everyone. Welcome to NetScout's third quarter fiscal year 2022 conference call for the period ended December 31, 2021. 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 No. 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, which are described on this slide and in today's financial results press release, as well as in the company's annual report on Form 10-K for the year ended March 31, 2021, 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 turn to Slide No. 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 they are also on our website. I will now turn the call over to Anil for his prepared remarks.

Anil?

Anil Singhal -- President and Chief Executive Officer

Thank you, Tony. Good morning, everyone, and thank you for -- thank you all for joining us today. Let's begin on Slide No. 6 with a brief recap of our third quarter and first nine months' non-GAAP results.

During the third quarter, we delivered strong performance across the board. Higher quarterly sales, margins, and profitability were mainly driven by increased enterprise customer demand and customers' acceleration of orders, primarily within our service provider vertical of approximately $25 million to $30 million that were previously forecasted to occur in the fourth quarter. As a result, we achieved strong top-line growth with revenue increasing more than 14% year over year to $262.2 million. Product revenue grew more than 25% and service revenue grew more than 3%, both on a year-over-year basis.

We exited the third quarter with a product backlog of approximately $30 million in unshipped orders, which excludes radio frequencies, propagation, modeling orders. Moving to our bottom line, based on the third quarter's revenue performance and product mix, diluted earnings per share increased to $0.89 from $0.66 a year ago, an increase of approximately 35%. On a year-to-date basis, revenue in the first 9 months of fiscal year 2022 increased more than the 7% to $664.4 million. This was driven by product revenue growth of more than 17%, partially offset by a 0.8% decline in service revenue.

Diluted earnings per share increased approximately 29% to $1.56 for the first nine months of the fiscal year. These comparisons are all made on a year-over-year basis. In summary, our strong third quarter performance has further demonstrated the financial strength of our business model. This success, combined with our year-to-date results, has provided us with even greater clarity into our full fiscal year outlook and the confidence to update it.

I'll also provide more details on all of this later in my remarks. Let's now move to Slide No. 7 for some further perspective on market and business insights. Starting with markets, we continue to see digital connectivity increasing around the world accelerated by the pandemic and longer-term technology trends.

NetScout now has more than three decades of experience providing service assurance and cybersecurity solutions as the crossroads of modern business performance and cutting-edge technology. Since then in our inception, we have developed a solid reputation for being innovative, delivering industry-leading solutions and cultivating close net customer relationships. Our established mindshare and best-in-class solutions have positioned us well to capitalize on the world's growing connectivity. To address the latest challenges of customers dealing with the new normal, hybrid workforces, edge connectivity, and the ever-expanding cybersecurity threat landscape, we recently released several new products, including Smart Edge Monitoring and our Omnis Cyber Intelligence.

We are excited about the potential of these recently released products and services, which are starting to gain traction, and we believe that this offering will further accelerate our business momentum in the next fiscal year and beyond. We are also actively working with many of our partners to better integrate our solutions into their ecosystems and thereby enhance the overall quality and technical capabilities of some technology tools. Michael will provide more context on these developments during his remarks. Now I would like to discuss our customer verticals to provide more perspective on our performance as well as the related trends that we are seeing.

For the first three quarters of fiscal year, we grew revenue in our service provider by customer vertical by more than 7% year over year. And as mentioned earlier, in the third quarter, several service provider customers accelerated orders with us that were previously anticipated to occur in the fourth quarter of fiscal year 2022. In terms of trends for this vertical, we continue to see 5G deployed globally and our radio frequency propagation modeling solutions being used in the carrier planning. Last week, for example, two Tier 1 domestic carriers lit up their 5G networks at the leverage mid-band spectrum to deliver their solution.

Meanwhile, the latest FCC mid-band spectrum auction in the U.S. just raised over $22 billion. These events further underscore the industry's steady progress and persistent interest in 5G-related initiatives. We continue to win notable service provider deals in the third quarter, which included more 5G-related orders from Tier 1 domestic and international carriers.

We also won a second large radio frequency propagation modeling order from a Tier 1 domestic carrier as our organization continues to advance its 5G network planning. Michael will comment on some of these service provider wins in his remarks. Now moving to our enterprise customer vertical. Revenue for this vertical grew by more than 7% year over year in the first three quarters of our fiscal year.

In line with our remarks from last quarter, we continue to see enterprise customer moving from reactivity to proactivity in their execution as they restart projects previously delayed by the pandemic and adjustment to the new normal of operating environment. Michael will highlight some of the customer wins we achieved during the quarter in this vertical in his remarks. Now let's move to Slide No. 8 to review our outlook.

Looking back on our business performance so far, we have delivered three quarters of solid results with strong business momentum. Importantly, our third quarter performance has demonstrated the financial strength of our business model and provided us with even greater clarity and confidence regarding our fiscal year 2022 forecast. We remain on track to meet our financial objectives for the full fiscal year. And after considering all these factors, we have made the decision to update our full year guidance, raising our revenue midpoint and increasing our EPS outlook for the fiscal year 2022.

These updates reflect our expectation for lower product revenue in the fourth quarter attributable to the previously mentioned acceleration of orders by customers, and movement of revenue from fourth quarter to our third quarter results. It also reflects our expectation to end the fourth quarter with a product backlog of unshipped orders similar to that of the third quarter. Jean will provide additional color and recap on the numbers on her remarks. In conclusion, we have then performed well year-to-date, our visibility has further improved, and our business model has demonstrated significant financial strength.

We remain excited about our future growth prospects, and I really look forward to sharing our first -- final year fiscal year 2022 results and our fiscal year 2022 -- '23 outlook with everyone on our next earnings call. With that, I'll turn the call over to Michael.

Michael Szabados -- Chief Operating Officer

Please turn to Slide 9. Thank you, Anil, and good morning, everyone. Slide 10 outlines the areas I will be covering today. Customer wins.

We continue to see momentum around in our 5G in our service provider customer vertical. As Anil mentioned, we received 5G-related orders from both the domestic Tier 1 as well as international carriers in the third quarter. One of these deals was a low eight-figure order from our -- for our 5G-related solutions from a certain domestic Tier 1 carrier, which represents the third 5G-related order this carrier has placed with us. The international market also continued to show momentum.

We received a mid-seven-figure order for our 5G-related solutions from an international carrier in the third quarter, which represents the second 5G-related order from this organization. We also received a second low eight-figure order from a domestic Tier 1 carrier from additional radio frequency propagation modeling services as the carrier continues to plan its 5G network buildout as these carriers increasingly look to integrate 5G capabilities and further advance the competitiveness of their offering. Our unique combination of market-leading solutions, depth of experience, responsive customer service, and strong relationships continue to be able to win us business in this service provider segment. We have also continued to observe renewed momentum within our enterprise customer vertical.

As Anil touched on earlier, these customers are now in the process of refocusing on those important projects that were either previously delayed due to the pandemic constraints or newly created as a result of the broad impact of the pandemic on underlying digital transformation trends today. We are well positioned to capitalize on this momentum and our robust suite of offerings is gaining traction with both existing and new enterprise customers. During the third quarter, for example, we won a low seven-figure deal with a new customer that is a global household and consumer products company headquartered in the U.S. By demonstrating to the customer our ability to help protect its critical business services from disruptions, we were able to win this deal after only a very short sales cycle.

Once the customer's IT operations experienced a massive data center breakdown, their IT operations management team realized they did not have the ability to resolve, let alone prevent such problems using their existing tools. This is another example of rapidly growing complexity within IT today. IT has already reached a critical threshold that necessitates visibility at a larger scale than possible with conventional IT tools. Beyond our example and due to the result of similar IT challenges, we have won several noteworthy new clients, including a new agency in the U.S.

Department of Defense. These wins further demonstrate the highly differentiated nature of our approach as well as the depth and breadth of our offering, which continue to serve us well in today's dynamic and constantly evolving digital economy. Now turning to our go-to-market activities. On this front, we remain focused on cultivating strong partnerships, integrating solutions and preparing for our Engage 2022 Annual User and Technology Summit.

From a partnership and integration perspective, we recently announced several new and continuing collaborations. To highlight a few, in early November 2021, we reported that AWS customers will now be able to use Omnis Cyber Intelligence, or OCI, integration with AWS Security hub for added visibility and security when migrating [Inaudible] to AWS. Earlier this month, we also announced our collaboration with AWS in support of ENGIE IT, the IT subsidiary of a worldwide low-carbon energy supplier, ENGIE, to seamlessly migrate its workloads and services to the cloud in support of the company's digital transformation journey. Finally, at the end of the year, we announced a new integration that connects NetScout's nGeniusONE service assurance solution with ServiceNow IT Operations Management, or ITOM Visibility and ITOM Health.

Our integration module is enabling nGeniusONE to generate enhanced alerts to service now ITOM with the context to launch capability for service triage. We are excited about these partnerships, the people we are working with, and the quality of our solution integrations thus far. Through these collaborations, we can help our customers navigate our increasingly connected and interdependent world with more confidence and protection so they can focus on what matters most to their organizations. Looking ahead, NetScout plans to host its customers and partners at its Annual Engaged Technology and User Summit from April 25th to 28th this year in Orlando, Florida.

As an annual tradition, this event is a true highlight of the year for NetScout. At Engage 2022, we plan to showcase our cybersecurity, service assurance and the DDoS capabilities through presentations, panel discussions, demonstrations and hands-on training. This event will also provide us with more opportunities to meet with our user and partner communities to discuss and solicit feedback regarding our visibility without borders offerings. That concludes my prepared remarks, and I will now turn the call over to Jean.

Jean Bua -- Executive Vice President and Chief Financial Officer

Thank you, Michael, and good morning, everyone. I will now review our key third quarter and year-to-date fiscal year 2022 metrics. 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 No. 12 details the results for our third quarter and year-to-date fiscal year 2022. Focusing on the quarterly performance, revenue grew 14.6% over the same quarter in the prior year to $262.2 million. Product revenue grew 25.6% and service revenue grew 3.5% over the prior year's quarter.

Our third quarter fiscal year 2022 gross profit margin was 78.8%, up 0.2 percentage points over the same quarter last year, primarily attributable to product, volume, and mix. Our third quarter software-only revenue was 34% of our service assurance product revenue, compared to 31% in the same period last fiscal year. Quarterly operating expenses increased 3.5% from the prior year, largely due to investments in sales and marketing. We reported an operating profit margin of 33.2%, compared with 28.2% in the same quarter last year.

Diluted earnings per share was $0.89, compared with $0.66 in the same quarter last year. Turning to Slide 13, I'd also now like to review key revenue trends for the first nine months of fiscal year 2022. Year to date, the service provider customer vertical revenue grew approximately 7.4% while the enterprise customer vertical grew approximately 7.7%. Approximately 51% of total revenue for the first nine months of the fiscal year was generated from the service provider customer vertical while the remaining 49% was from the enterprise customer vertical.

Turning to Slide 14, which shows our geographic revenue mix on a GAAP basis, revenue by geography continues to be domestically weighted, both domestic and international revenue increased on a year-to-date basis. For both the third quarter and first nine months of the fiscal year, there was one customer that represented 10% or more of total revenue. Slide 15 details our balance sheet highlights and free cash flow. We ended the quarter with $553.5 million in cash, cash equivalents, and short-term and long-term marketable securities, representing an increase of $77.7 million since the end of the second quarter.

Free cash flow generated in the quarter was $90.3 million. We repurchased approximately $11 million or 409,379 shares of our common stock in the quarter. From a debt perspective, as of the end of the third quarter, we had $350 million outstanding on our $800 million revolving credit facility, which expires in July 2026. To briefly recap these balance sheet highlights, accounts receivable net was $233.9 million, up by $36.2 million since the end of March.

The DSO metric was 76 days versus 75 days at the end of the fiscal year 2021 and 70 days at the same time last year. Moving to Slide 16 for commentary on our outlook, I will focus my review on our non-GAAP outlook. As Anil noted earlier in his remarks, we have updated our full year outlook, raising our revenue midpoint and increasing our EPS outlook for fiscal year 2022. We now expect fiscal year 2022 revenue to be in the range of $850 million to $855 million.

Assuming approximately 75 million weighted average diluted shares outstanding, we expect non-GAAP diluted earnings per share to be between $1.75 and $1.78. This update reflects our expectation for lower product revenue in the fourth quarter as a result of the previously mentioned acceleration of product revenue of approximately $25 million to $30 million from the fourth quarter into our third quarter results. It also reflects our expectation to end the fourth quarter with a product backlog of unshipped orders of approximately $30 million, which also excludes radio frequency propagation modeling projects and is similar to that backlog of the third quarter. That concludes my formal review of our financial results.

I'll now turn the call over to the operator to start Q&A.

Questions & Answers:

Operator

[Operator instructions] We will take our first question from Matt Hedberg with RBC Capital Markets.

Matt Hedberg -- RBC Capital Markets -- Analyst

Hey, guys. Thanks for taking my questions. Congrats on the quarter. Anil, obviously, there's a lot of positive this quarter.

And then I guess I'm curious the acceleration in service provider deals this quarter, is it just a function of timing or was there anything else that caused some of these deals to accelerate this quarter?

Anil Singhal -- President and Chief Executive Officer

Matt, I think the main reason was, as we have mentioned, a little bit of this happened in last quarter also. I mean the big service -- big deals often done by big service provider customers with larger orders -- it requires -- has some challenges with many other vendors, who have a bigger hardware content because of supply chain problems. And as a result, they wanted to use their year-end budgets, and that we think is really the most -- I mean, most likely reason why we got Q4 orders moved into Q3. So that's a fact, which has been happening, but it was more prominent in the third quarter because even though it's the third quarter for us, it's the fourth quarter fiscal quarter for all of them.

And that put a lot of pressure on us to ship things, but we had to do then be -- it because of customer satisfaction reasons.

Matt Hedberg -- RBC Capital Markets -- Analyst

Got it. That makes a ton of sense. And then I think one question that we get from a lot of investors is potential questions about supply chain constraints. It doesn't look like that impacted you this quarter or in your guidance, but any commentary on if that's something you guys think about just kind of given your global reach?

Anil Singhal -- President and Chief Executive Officer

Well, yes. We see that also, but they have not been detrimental to our revenue and orders. And for example, that there are challenges in disk drives. We use a lot of disk drives for our packet recording and such everything and so sometimes, we have to pay more.

And so we have been managing our margin despite paying some higher cost. And so we have those problems, but since -- we don't make custom hardware, but we do use a lot of hardware from third parties and otherwise and there have been people who buy hardware from our preferred supplier. And there, we had to work with them to keep inventory enough of them. There are people who buy directly from other vendors.

And those things have been delayed and as a result, sometimes it affects the delay of the shipment of our orders also, so. But overall, we feel that the challenges we are facing also, but they pale in comparison to many other companies in our space.

Matt Hedberg -- RBC Capital Markets -- Analyst

Got it. That makes a ton of sense. Thanks, Anil. Thanks, everybody.

Anil Singhal -- President and Chief Executive Officer

Sure.

Jean Bua -- Executive Vice President and Chief Financial Officer

Thank you.

Operator

We will go next to James Fish with Piper Sandler.

James Fish -- Piper Sandler -- Analyst

Hey, guys. Nice execution there. On the guide, there was another quarter in which you saw a pull-in of deals. I guess, what makes you think it's more of a pull-in of deals rather than just rising demand or even an acceleration of the 5G cycle in terms of the time frame? Was deferred revenue also was materially higher than normal? Is there any way to think about also your total backlog sequentially, including the radio frequency? So really, what I'm trying to understand is why wouldn't we have seen some of larger guide rates here on the strength the last few quarters, the demand environment, and upside and lead metrics?

Anil Singhal -- President and Chief Executive Officer

The main reason is because we have -- obviously, have the forecast and very credible forecast in December for the Q4, so we see a clear decrease in forecast for Q4 from the sales team as a result of what happened in Q3. And that's the primary reason, like for all these big deals, eight-digit deals, we have, I mean, clear idea of which quarter they then really fall. And that's what happened in this time that our forecast for Q4 for those big, large customers had correspondingly decreased in Q4 versus Q3. So I wish that there is a 5G acceleration, and that will be great for us.

And yes, there is a lot of talk about 5G, but we don't think that with ex 5G acceleration is the primary reason for this earlier-than-expected orders.

Jean Bua -- Executive Vice President and Chief Financial Officer

Hi, Jim. This is Jean. I just want to comment on one of your observations about deferred revenue and put it in context of the backlog. As you know, from our Q disclosure, our backlog was about just round numbers, $80 million to $85 million at the end of Q2.

In total, the backlog going into Q -- out exiting Q3, including radio frequency calibration, is about $75 million. And that is actually a portion of that you'll see needing in deferred revenue because one of our large carriers asked to -- us to please build them for the project before it was actually completed. So you'll see the deferred revenue was up by $20 million, $25 million due to that. And that's one of the reasons why the DSO is up at 76 because the invoice went out but the revenue hasn't been recognized yet.

James Fish -- Piper Sandler -- Analyst

That's really helpful. And Jean, on the security side, obviously, service assurance had a really good quarter. Didn't hear as much on the security element. Can you just give us an update on what percentage of revenue security represents for you today? And so what it grew year over year in the breakdown within Arbor only between service provider and enterprise?

Jean Bua -- Executive Vice President and Chief Financial Officer

So I would say that Arbor is still roughly on our guidance, probably roughly, just round numbers, 25%. For the quarter, they grew in the mid-teens. And they grew mostly in service provider, and were relatively flat in enterprise. So on a year-over-year basis, the overall growth is approaching the mid-single digits.

And again, it's skewed mostly toward service provider, and our enterprise tends to be flat on a year-over-year basis.

James Fish -- Piper Sandler -- Analyst

Helpful. Thanks, guys.

Jean Bua -- Executive Vice President and Chief Financial Officer

Thank you.

Operator

And we will go next to Kevin Liu with K. Liu & Company.

Kevin Liu -- K. Liu and Company -- Analyst

Hi. Good morning. Just wanted to start on the service provider side as well. Obviously, you have the prior C-band auction and now some of that is getting lit up by your large Tier 1s, and you've seen some benefits this in your product revenue growth.

So wondering if you could kind of walk us through subsequent to the prior C-band auction, how that can sort of benefit your business or flowed into it? And what you expect following this latest round of mid-band auction?

Anil Singhal -- President and Chief Executive Officer

So there are two factors, Kevin. One is that we are the incumbent in the 4G space. And so as they come out with 5G RFPs and all that, we still have to go through the mechanics of winning the business. So our 5G wins are really extension of our 4G incumbency and all the investments we have made.

So all the carriers we were talking about, Michael had talked about, are really doing 5G as an extension of our success in 4G, and that's about the previous spectrum and all those. The new spectrum oftentimes requires new propagation delay solutions. And so we think that new spectrums are then laid out. It's going to affect our propagation-based solution, which Michael talked about, with regard to large orders.

And we have been working with smaller carriers now and on a more software-based solution for the propagation management, which could be applicable and more cost effective for them. So that's now what this looks like at existing spectrum moving from 4G to 5G as a result of our incumbency for new -- for the planning purposes on the new spectrum, we have these second kind of orders.

Kevin Liu -- K. Liu and Company -- Analyst

Got it. And maybe switching over to the enterprise side of things. You guys have seen kind of building momentum there over the course of the year. As you look forward here, do you feel like this is kind of a good in cadence in terms of the -- where you want growth to be for this vertical or do you see further opportunity for acceleration?

Anil Singhal -- President and Chief Executive Officer

Yes. We see that even though there was not a big contribution of this in this year, but all the projects we -- all the two big areas we announced, Smart Edge Monitoring for service assurance solution beyond the data center and Omnis Cyber Intelligence, which we feel is an adjacency with a big market size for us, are both tracking very well. And I guess so while there is not much contribution to these because of -- we just released them three to six months ago, there is a lot of interest. We already have few -- quite a few customers, and we think that's going to be a big driver for growth next year in the enterprise.

Michael Szabados -- Chief Operating Officer

I might want to add just one other point. I do believe that there is going need for our scale of solutions, scale of visibility that other tools cannot handle, and that's because of the growing complexity and then all of these additional digital transformation moves is that inevitable for the large customers to arrive at this kind of solutions. I also see this trend.

Anil Singhal -- President and Chief Executive Officer

Yes.

Operator

And we have no further questions at this time. I'll turn it back to the speakers for any closing remarks.

Tony Piazza -- Vice President of Corporate Finance

Great. Thank you for joining us today. This now concludes our call. Have a nice day.

Thank you.

Operator

[Operator signoff]

Duration: 44 minutes

Call participants:

Tony Piazza -- Vice President of Corporate Finance

Anil Singhal -- President and Chief Executive Officer

Michael Szabados -- Chief Operating Officer

Jean Bua -- Executive Vice President and Chief Financial Officer

Matt Hedberg -- RBC Capital Markets -- Analyst

James Fish -- Piper Sandler -- Analyst

Kevin Liu -- K. Liu and Company -- Analyst

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