Netscout Systems Inc (NTCT) Q2 2027 Earnings Call Transcript

Thank you for standing by, and welcome to NetScout's second quarter fiscal year 2027 financial results conference call. At this time, all parties are in a listen-only mode. A question-and-answer session will follow the management team's prepared remarks. As a reminder, this call is being recorded. If you require operator assistance at any time, please press star zero. I would now like to turn the call over to Scott Dressel, NetScout's VP of Corporate Finance. Scott, please go ahead.

Thank you, Operator, and good morning, everyone. Welcome to NETSCOUT's second quarter fiscal year 2027 conference call for the period ended September 30, 2026. Joining me today are Anil Singal, NETSCOUT's President and Chief Executive Officer, and Tony Piazza, NETSCOUT's Executive Vice President and Chief Financial Officer. Please note that a slide presentation 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 our investor relations section of our website at www.netscout.com, including the IR landing page and the quarterly results page. As discussed in detail on slide number three, today's conference call will include certain forward-looking statements about NETSCOUT's views on expected results of future performance and business strategy. These statements speak only as of today's date and involve risks, uncertainties, and assumptions that may cause actual results to differ materially. Including, but not limited to, those described in our company's filings with the Securities Exchange Commission, including our annual report on Form 10-K and quarterly reports on Form 10-Q. As discussed in detail on slide number four, today's conference call will also include discussion of certain non-GAAP financial measures that the company believes to be useful for investors. While the slide presentation includes both GAAP and non-GAAP results, Other than revenue and balance sheet information which are presented in accordance with GAAP, we will focus our discussion on non-GAAP financial information. 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 to the nearest GAAP measures are provided in the appendix of the slide presentation. In today's financial results, press release, and on our website. I will now turn the call over to Anil for his prepared remarks. Anil.

Thank you, Scott, and good morning, everyone. We appreciate you joining us today. Our second quarter results were consistent with our expectations, and our first half performance keeps us on We are on track to achieve our objectives for fiscal year 2027. Our continued focus on cost-discipline supported operating margin expansion from the prior year. We were also active in our shareholder repurchase program during the quarter, reflecting our commitment to returning capital to shareholders. With that foundation, we are reaffirming our full-year outlook. In October, we hosted our annual Engage Technology and User Summit. Showcasing our newer solutions to more than 400 customers and partners. These innovations extend our scalable DPI-derived AI-ready smart data into AI ops and agentic workloads, as well as strengthen our cybersecurity and DDoS attack protection portfolios. While customer AI adoption is still in its early stages, we view this as a strong long-term opportunity. As investment matures, We will be well positioned to expand within our install base and capture new opportunities. With that context, let me turn to slide 6 for a brief overview of our financial performance. For this second quarter of fiscal year 2027, total revenue grew 1.4% to $22.2 million, reflecting the timing of certain audits pulled into Q1 from Q2, as discussed last quarter. Operating margins expanded, and diluted earnings per share increased to $0.71 compared with $0.62. For the first half of Fiscal Year 2027, revenue grew nearly 7% to approximately $433 million, reflecting growth in both cybersecurity and service assurance. Gross and operating margins expanded, and diluted earnings per share increased to $1.23 compared with $0.95. Now, let's turn to slide number seven for some perspective on business and some market insights. Starting with service assurance, revenue increased approximately 8% for the first half of the fiscal year, driven by the timing of strong federal government-related orders. Enterprise customers continued to turn to Netscout to close the visibility gaps created by hybrid cloud automation and AI workload, and we strengthened our solution during the quarter. We expanded our data platform, which observes digital interactions and converts packets in real time into compact, contextualized evidence for observability, service assurance, cybersecurity, and AI. By applying early semantic extraction at the point of observation, our AI systems reason from actual data rather than inference. In our internal testing, this approach meaningfully reduced AI token consumption and mean time to knowledge, helping customers improve decision confidence and lower the cost of AI-driven analysis. We also launched Ingenius Co-Pilot, a conversational AI extension to Ingenius1 that turns natural language questions into evidence-based answers, increasing usability for a broad range of professionals. Our service provider customers remain focused on reducing network costs and complexity, as well as improving automation across fixed mobile and edge environments. Our 5G observatory solution gives them end-to-end visibility for standalone 5G networks and supports emerging use cases, including fixed wireless access and network slicing. Carrier spending remains disciplined and tight. Even so, customers continue to select Nestor to help improve efficiency and monetize their next-generation network investment. Beginning in fiscal year 2028, we will rename service assurance as network observability to better align with industry terminology. Network observability is the term of the industry now uses for these solutions, and the new name reflects how our customers see this part of our business, and the broader opportunity set our solutions are starting to address. Turning to cybersecurity, a revenue increase of approximately 4% in the first half of the fiscal year, reflecting contribution for more expanded hardware cloud capacity. Cybersecurity continues to be an important long-term growth opportunity as the threat environment continues to intensify and DDoS attacks become more frequent, sophisticated, and difficult to mitigate. In our first half, 2026 DDoS Threat Intelligence Report released in October, we noted that high-capacity attacks are no longer anomalous and are now routine. Adversaries are increasingly using residential proxies, short-duration attacks, and DDoS for higher services. This means customers require finer-grained network control, selective mitigation, and more scrubbing capacity at the network edge. To address this expanding need, we have extended adaptive DDoS protection from attack target to its source by automatically detecting and mitigating outbound attack traffic. Helping service providers stop compromised subscriber devices before they disrupt their networks, consume costly capacity, or attack organizations across the Internet. Secondly, we have enhanced Arborized Edge defense to identify attack sources hidden behind content delivery processes, adding an independent layer of protection for enterprises' revenue-generating applications without requiring CDN provider replacement. Regarding AI, our packet-derived smart data differentiates Neskort by providing AI models with the quality operational context needed for more effective reasoning and outcomes. Customers are buying AI solutions designed for service assurance and using them for cybersecurity applications, bringing the two areas closer together. In September, we unveiled Model Context Protocol, or MCP, connectivity to our Omnit AI Insight solution. It gives AI assistants and agents on-demand access to AI-ready smart data. NETCOR real-time operational evidence, providing the trusted contacts they need to support more accurate and informed decisions. Customers can stream smart data into the platform they already use and add capability to the existing network infrastructure without re-platforming. While customers are still defining their AI strategies, we are encouraged by the level of engagement and expect adoption to build over time. Moreover, our install base and income base provides a meaningful advantage as programs move into production. That brings me back to Engage 2026. Our team, moving from proactive to predictive, spoke to how our customers are advancing beyond monitoring to detect issues earlier, predict outcomes more accurately, gain greater insight, and automate more decisions. Our AI-ready smart data, our values, and our customer focus provide a trusted foundation for that shift. With more than four decades of experience adapting to each area of technological change, expanding our purpose and innovation solutions, we are built to help our customers as their AI strategies evolve. Turning to customer wins, we saw continued demand across both service assurance and network observability and cybersecurity offerings. New and existing customers invested in new solutions, upgrades, and maintenance services. Second quarter highlights included wins from two longstanding customers. We secured a high seven-figure win with a leading U.S. financial institution to build out a new infrastructure to support customer-facing networks, as well as operate internal unified communication and network performance capabilities. The repeat business underscores the strength of our relationship and our mission critical role ensuring the performance and resilience of its digital environment, including large multi-cluster Kubernetes deployments. We also want a low seven-figure order with a leading global service provider that relies on our hardware products to deliver a managed DDoS service to its own customers. The customer purchases our adaptive DDoS. Protection Solution, which leverages our Atlas Intelligence feed to combat the increasing frequency and complexity of DDoS attacks, including outbound and carpet bombing attacks as it attacks to a rapidly expanding threat environment. With that, let's move to slide 8 and review our outlook. We remain focused on profitable growth, healthy, free cash flow generation, and long-term shareholder value. Based on our first-off results, we are reaffirming our full-year 2027 outlook. Customer remain disciplined in their spending, and we are managing the business accordingly. At the same time, we see meaningful long-term opportunity in network observability, AIOps, and DDoS attack protection. We'll keep investing in innovation, including using our data and intelligence to power AI-driven workflows that enhance resilience and service reliability for our customers. We look forward to sharing our progress with you throughout the remainder of the fiscal Before I turn the call over to Tony, I want to briefly address a leadership change we recently disclosed. Sanjay Mishin designed as Chief Operating Officer effective October 22. We thank Sanjay for his contribution to NetSource and wish him well. Our experienced leadership team knows our business, customers, and partners, and members of their team have assumed additional responsibilities. We remain focused on executing our strategy, serving our customers, and delivering on our fiscal 2027 priorities. With that, I will turn the call over to Tony for a review of our financial performance and our outlook.

Thank you, Inou, and good morning, everyone. We appreciate you joining us. I'll start by walking you through the key financial metrics for the second quarter and first half of fiscal year 2027. After that, I'll share some additional commentary on our full fiscal year 2027 outlook, including some color on our expectations for the third quarter. As a reminder, other than revenue and balance sheet information, which are on a GAAP basis, this review focuses on our non-GAAP results. All reconciliations with our GAAP results appear in the presentation appendix. I will note the nature of any such comparisons accordingly. Also, all comparisons on a year-over-year basis unless otherwise noted. Slide number 10 details the results for the second quarter and the first half of fiscal year 2027. Focusing on the quarterly performance, total revenue increased to $222.2 million, compared with $219 million in the same period last fiscal year. As a reminder, these results reflect the timing of government-related orders that were received earlier than anticipated and benefited the first quarter. Product revenue was $89.9 million, down 5.1%, reflecting the timing of government-related orders as mentioned. Service revenue was $132.3 million, up 6.4%. We ended the second quarter with total product backlog of approximately $21 million, which included $15 million of fulfillable backlog. The gross profit margin was 80.9% compared with 81.4% in the prior year period, reflecting overhead costs associated with the DDoS asset acquisition. Quarterly operating expenses were $116.9 million, down 2.7% year-over-year. As we noted last quarter, the comparison benefited from our Engage User Summit shifting from the second quarter last year to the third quarter this year, along with continued cost discipline. Operating margin was 28.3%, compared with 26.5% in the same quarter last year. We delivered net income of $52.8 million, or diluted earnings per share of 71 cents. Compared with net income of $45.1 million, or $0.62 per diluted share in the year-ago quarter. The first half of fiscal year 2027, total revenue was $432.6 million, an increase of 6.6%, and diluted earnings per share was $1.23. Compared to $0.95 for the corresponding period last fiscal year. Let's turn to slide 11, where I will walk you through the key revenue trends by product lines and customer verticals. As a reminder, revenue presented is on a gap basis, and all comparisons continue to be on a year-over-year basis. For the first half of fiscal year 2027, Service assurance revenue increased by 8.2%, and cybersecurity revenue grew by 3.8%. During the same period, service assurance accounted for approximately 66% of our total revenue, and cybersecurity accounted for the remaining 34%. As Anil noted, beginning in fiscal year 2028, we will report service assurance as network observability. Turning to our customer verticals, for the first half of fiscal year 2027, enterprise revenue grew 9.1%, while service provider revenue grew 2.8%. During the same period, enterprise accounted for approximately 62% of our total revenue, and service provider accounted for the remaining 38%. Additionally, no one customer accounted for more than 10% of our revenue for the second quarter or the first half of fiscal year 2027. Turning to slide 12, for the first half of fiscal year 2027, 57% of our revenue was generated from the United States, with the remaining 43% coming from international markets, which is consistent with the prior year period. Slide 13 shows key balance sheet items and free cash flow for the period. We ended the second quarter of fiscal year 2027 with $571.3 million in cash, cash equivalents, and short- and long-term marketable securities, compared with $705.1 million at the end of fiscal year 2026. Free cash flow was a use of $17.8 million for the second quarter, driven by the timing of working capital. We repurchased approximately 2 million shares of our common stock for approximately $77 million during the second quarter. We currently have capacity under our share repurchase authorization and, subject to market conditions, intend to remain active in the market during During the remainder of fiscal year 2027. From a depth perspective, we have no outstanding balance on our $600 million Volvling credit facility, which expires in October, 2029. Let's move to slide 14 for our fiscal year 2027 outlook and some additional color on the third quarter. As Anil noted, we are reaffirming the fiscal year 2027 outlook we provided last quarter. We continue to expect year-over-year growth in both revenue and earnings with the following assumptions for the full fiscal year. Revenue in the range of $885 to $915 million. Non-GAAP EPS in the range of $2.65 to $2.80. A non-GAAP effective tax rate of approximately 20%, and weighted average diluted shares outstanding of approximately $74 million to $75 million. Next, let me provide some color on our third quarter outlook. As a reminder, last year's third quarter included approximately $15 million of revenue from orders that customers pulled forward from the fourth quarter, which makes for a tougher comparison. Based on our current pipeline and the expected timing of customers' projects and orders, we expect third-quarter revenue in the range of $240 million to $250 million. Excluding the $15 million dollars pulled forward last year, that would imply growth in the low to mid-single digits. As mentioned earlier, third-quarter operating expenses will also include the cost of our Engage User Summit. We shifted from the second quarter last year to the third quarter this year. As a result, we expect third-quarter non-GAAP diluted earnings per share for Q3 in the range of $0.90 to $0.95. In summary, we continue to execute on our plan and remain focused on achieving our fiscal year 2027 objectives. Our capital allocation priorities remain consistent, investing in profitable growth, Maintaining a strong financial position, and returning excess capital to shareholders over time, primarily through share repurchases. We believe NetScout is well-positioned to support customers as their network, security, and operations environments become more complex. Our expertise in network observability and cybersecurity, together with our AI-ready smart data platform, Gives customers a trusted foundation for digital transformation and AI-enabled operations. That concludes my formal review of our financial results and outlook. Before we transition to Q&A, please note that our upcoming investor conference schedule is provided on slide 15. We will be attending the RBC and Needham investor conferences later this month and the UBS conference in December. We hope to see many of you there. Thanks again for joining the call. I will now turn the call over to the operator for questions. Operator? Thank you.

At this time, if you would like to ask a question, please press star 1 on your telephone keypad. If you wish to remove yourself from the queue, press star 2. In the interest of time, we ask that you limit yourself to one question and one follow-up. We'll take our first question today from Eric Supacher with B. Riley Securities. Your line is now open.

Yeah, thanks for taking the call, and congrats on a good, profitable quarter. First off, any comment on what federal was in the quarter? It sounds like it was continued with some strength from the last quarter. And then, can you comment in terms of what growth you're seeing out of your smart data product? I think you've talked about that generating around $15 million last year. Any thoughts on what we might think about in terms of annualized growth in fiscal 27?

Yeah, so just on the federal, so for the first half, federal, so federal. Federal revenue generally runs in mid to high single digits as a percentage of total revenue. So for the first half, it's running in, let's say, the low teens. So, you know, it's been strong in the first half. And we have a good pipeline going into the second half. The thing with federal that we always caution is that the timing and magnitude of orders can be less predictable. So we do have a lot of good pipeline there. We're just looking at when the timing of those projects will hit in the quarters.

So, last year was the early adopter theme and a couple of large customers made most of the smart data consumption and on this revenue. This year, as we mentioned, it's a long sales cycle, but we have a dramatic increase in funnel. But sales cycles are long, so it's not clear right now. Maybe we'll have something more to share towards the end of the fiscal year, how much will be the growth in that. But interest level and the traction on the funnel is just very, very impressive. And all the analysts and customers at our Engage event were very excited about this area of growth for us. And I think, Eric, as we talked about, on a prior call, when we launched some of these AI, Omnus AI solutions, we did it through a select customer group as pilots and kind of working through some of it.

So we recently reintroduced It's to the larger group at Engage, and like Anil said, there's been a lot of interest in it, but, you know, it does take a little time as customers work through their AI strategies and build it into their budgets and stuff like that.

Okay, since you can't give me a growth on that, can you give us a sense on what kind of growth you're expecting out of the cyber product in fiscal 27?

Yeah, so I would say cyber, it'll probably be in the mid-single digits for cyber. I think in the prior year, we did have some large customer refreshes that we're trying to work through right now. So in my sense, it's the mid-single digits.

And then for the AI product, Eric, whatever growth is there will be part of a service assurance. That's how we classify right now.

Very good. Thank you.

Excellent. Thanks, Eric. Thank you. Our next question comes from Suneika Mershant with RBC Capital Markets. Your line is now open.

Hey, guys. Thanks for taking my question, and congrats on the quarter. This is Konika on for Matt Hedberg from RBC. Could you talk a little more about the broader macroeconomic landscape and what demand trends have looked like? Thanks.

Well, I think if you are, I mean, there are obviously uncertainty both in the U.S. and abroad, and... And so, those are the external factors. The service provider spending continues to be tight and there is consolidation, continued consolidation. You saw Charter and Coop recently. Some time ago, it was, two, three years ago, it was Sprint and T-Mobile. There are things happening in the European front. So, that continues to create some challenges on the... On the Middle East front, our business is definitely impacted by a selected area because of the war and other things there in certain countries. So that's the external view. On the internal side, we can make up for this in other areas. Through the Smart Data Platform and Omnis product, which we announced recently, but because of governance issues and lot of hardware investment in AI, there are much longer sales cycles. So more impact of this will be seen in the next fiscal year, but we are very excited about the pipeline we are building and the number of customers in the pipeline in a very short time.

I think on the enterprise we're seeing some good demand there and good pipeline on the service provider. As Anil said, that particular market has very disciplined spending. There's consolidation and stuff like that going on. But we see the timing of a lot of the projects and some of the opportunities in front of us to offset some of this stuff.

Got it. Super helpful, Caller. Thank you. And just looking ahead, is there a path to sustainably accelerating revenue growth into maybe the high single digits or beyond over the next two to three years as we think about new products and what the company is investing in across the business? Thanks.

Can you repeat the question? Maybe a little louder. We couldn't hear very well.

Oh, sorry about that. So just looking ahead, I was curious on what you would say the key growth drivers for upside are in the next two to three years. Is there a path to sustainably accelerating revenue growth, maybe into the high single digits or beyond, especially as we think about new products and what the company has been investing in? Thanks.

Yeah, so any upside is going to be directly tied to our AI solution, and we think once the initial traction takes off, we'll see that, first of all, it's a multi-year. Some of the stuff is sold as subscription, so we will be building ARR that results in more predictability and upside in the future. Also, We are not relying on one of the external factors, which I forgot to mention earlier, to your question of macro environment. There's a big challenge in the supply chain because of hardware costs are going through the roof. The server prices are two or three times where it was last year. What is great about our AI strategy is that we need very little new hardware. It's basically like a second floor. All these factors, a lot of interest in our smart data, pipeline build, as well as sales cycle challenges, beyond the next six to 12 months, not requiring, not dependent on the flight chain issues, and a lot of the pipeline build we have. I think it's an area where if there is an upside, it will be in there, but we're already – when we talk about single-digit growth, we are talking about double-digit GPS growth. So, I think we are already in the class by itself if we can maintain high single-digit growth.

Yeah, so I would say that the two areas are we're optimistic about what we're seeing on the AI opportunities and the pipeline, and then also in cybersecurity, that landscape keeps changing, and so we think there's good long-term opportunities in that particular market as well. And with regard to Anil's comment on the inventory, as you saw on our balance sheet, we did build inventory as we look to navigate this particular supply chain challenge.

Got it. Thanks, guys. Super helpful, and congrats again.

Thank you. Thank you. Our next question comes from Kevin Liu with Kalu and Company. Please go ahead.

Hi. Good morning, guys. Maybe just a quick follow-up on that last comment you made, Tony. In terms of the inventory levels, it sounds like that's purely kind of should address any potential supply chain challenges. Just wanted to clarify whether there was any sort of timing in there that impacted that and whether we can consider this kind of a new normal for the amount of inventory you'd like to carry going forward.

Yeah, no, I think it's a temporary increase in inventory relative to historical levels, so we believe the alternative could have exposed the company significantly to greater risk, but we expect inventory levels to normalize as the secured material is consumed and the supply conditions improve.

Understood. And just wanted to double click a little bit on kind of the demand environment for service providers. You know, as you look to the back half, do you think kind of the pacing at which, you know, your pipeline can convert is fairly similar? And with some of, you know, the newer use cases, whether it's fixed wireless access or enabling AI compute at the edge, just wondering whether they're talking to you about those opportunities and if you see that as kind of incremental to your existing service provider business.

Yeah, so first thing is we are doing, Kevin, is to stabilize the business, even if it is like making more predictable and doing some enterprise agreements and things like that. And I think that even if it increases the ASP slightly. And so once we have done that, which is we are in the process of doing. Which we call the strengthening the first floor and foundation of our service assurance business with service providers. I mean, we talked earlier about enterprise. Then we can go and layer the second floor, which doesn't require a hardware investment, and it's very, very attractive to people who are there. So, that's what's going to happen next year. But right now, we are focused on stabilizing, making both predictable. And we've made some kind of a multi-recommend with many of the providers.

Understood. Thanks for taking the questions and good luck here in the second half.

Thanks, Kevin. Thanks.

Thank you. This does conclude today's question and answer session, as well as NetScout's second quarter fiscal year 2027 financial results conference call. Thank you for joining today. You may now disconnect.