NTCT - NASDAQ

Ladies and gentlemen, thank you for standing by, and welcome to NETSCOUT's Second Quarter Fiscal Year 2026 Financial Results Conference Call. [Operator Instructions] As a reminder, this call is being recorded. Scott Dressel, AVP, Corporate Finance and his colleagues at NETSCOUT are on the line with us today. I would now like to turn the call over to Scott Dressel to begin the company's prepared remarks.

Thank you, operator, and good morning, everyone. Welcome to NETSCOUT's second quarter fiscal year 2026 conference call for the period ended September 30, 2025. Joining me today are Anil Singhal, NETSCOUT's President and Chief Executive Officer; and Tony Piazza, 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. As discussed in detail on Slide #3, 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 the company's most recent annual report on Form 10-K and subsequent filings with the Securities and Exchange Commission. As discussed in detail on Slide #4, today's conference call will also include discussion of certain non-GAAP financial measures that the company believes to be useful to investors. While this slide presentation includes both GAAP and non-GAAP results, other than the revenue and balance sheet information, 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. Thank you for joining us today. We delivered another solid quarter in Q2, driven by revenue growth from both our cybersecurity and service assurance product lines as we continue to advance our strategic initiatives, including AI-driven product innovation. Our strong top and bottom line performance also benefited from the acceleration of some orders originally anticipated in the second half of the fiscal year. Given our strong first half performance, we are raising our revenue and earnings per share outlook, which Tony will detail in his financial review. Let's turn to Slide #6 for a brief recap of our financial results for the second quarter and the first half of fiscal year 2026. Revenue was approximately $219 million, representing an increase of nearly 15% year-over-year, driven by solid growth in both our cybersecurity and service assurance areas of our business, along with the acceleration of certain orders originally anticipated to occur in our second half. We expanded both our gross and operating margins during the quarter and delivered diluted earnings per share of $0.62, an increase of approximately 32% year-over-year. For the first half of the fiscal year or the 6 months ended September 30, revenue was approximately $406 million, an increase in approximately 11% year-over-year, which benefited from a solid growth in both cybersecurity and service assurance area of our business, along with the previously mentioned acceleration of certain orders. We expanded both our gross and operating margin during the first half of the fiscal year and delivered diluted earnings per share of $0.95, an increase of approximately 27% year-over-year. Now let's turn to Slide #7 for some perspective in our business and some market insights. Starting with our Service Assurance offering. Revenue in the first half of the fiscal year increased approximately 10% year-over-year, driven by growth from both our enterprise and Service Provider customer verticals. We achieved solid growth across most of our major enterprise sectors with the federal government being particularly strong in the first half. This sector benefited from both underlying demand and the acceleration of certain orders expected in the second half. In the Service Provider area, growth was largely attributable to the timing of maintenance renewals, including back maintenance that processed in Q2 versus Q3 in the prior year. Our Enterprise customers are continuing to invest in digital transformation initiatives related to enhanced visibility, Observability and AIOps initiatives. Accordingly, we are driving intelligence into Observability and AIOps to feed the need for actionable telemetry derived from wire data and to leverage the unmatched power of our scalable DPI and metadata technology. We also recently launched our Omnis KlearSight Sensor for Kubernetes, which provides comprehensive observability within the complex cloud environment. It delivers deep, actionable and real-time insights into the system performance, health and cost drivers. The solution reflects our vision of visibility without borders and is specifically designed to support dynamic and distributed architectures, which are challenging environments to monitor due to their encrypted nature. On the Service Provider side, domestic and international carriers continue to align their investment with clearly defined 5G monetization opportunities such as fixed wireless access and private 5G. Although the Service Provider space remains challenging, we remain optimistic that NETSCOUT can capture further opportunities by delivering differentiated value as we continue to navigate the current environment. For example, we recently announced solutions to support cable providers and multiple service operators or MSOs with Omnis AI Insights, which generates a high fidelity curated data set to provide real-time network visibility, ensuring a high-quality user experience for video streaming and over-the-top services to help MSOs deliver high-quality user experiences more cost effectively. Moving to our cybersecurity offering. Revenue in the first half increased nearly 13% year-over-year, driven by growth in both our Enterprise and Service Provider customer verticals. Organizations continue to prioritize this area as they seek to protect themselves against an increasingly complex and expanding cyber threat landscape. In late August, we released our latest research detailing the evolving Distributed Denial-of-Service attacks landscape and how such attacks can destabilize critical infrastructure. Just in the first half of this year, Activist groups launched hundreds of coordinate attacks each month, targeting communications, transportation, energy and defense system. What is particularly concerning is how DDoS-for-hire services has made sophisticated attack tools available to virtually anyone. These attacks now use AI-enhanced automation, multi-vector approaches and carpet bumping techniques that overwhelm traditional defenses. Bot are compromising tens of thousands of IoT devices, servers and routers to deliver sustained attacks that cause real disruption and are creating an unprecedented level of cyber risk for organizations and Service Provider networks. NETSCOUT's solutions are designed to mitigate this risk by leveraging our unparalleled visibility into global attack trends. Moving on to customer wins. Our solution continued to gain traction with customers seeking to enhance their visibility, observability and cybersecurity capabilities, leading to combined solution wins across our Service Assurance and cybersecurity offerings within customer orders. Highlights for the second quarter include an Enterprise deal with multiple orders totaling an amount in the 8-figure range, part of which we received earlier than anticipated related to a U.S. government agency that we have been a loyal and long-standing user of our solution. These orders are follow-on orders from orders received last quarter and consist of both Service Assurance and cybersecurity solutions, including our new AI and cyber intelligence product. This user values our solution for the smart data we provide, which they are leveraging to enhance their user experiences and support AI-driven operations initiatives as they modernize their technology environment. Additionally, in the Service Provider area, we won a low 7-figure deal with a major U.S. telecommunication company that's another loyal and long-standing customer. This deal included our Adaptive DDoS and Distributed TMS cybersecurity solution that the customer had opted to purchase on a subscription basis. The cybersecurity solution purchase are designed to defend against the kind of carpet-bombing DDoS attacks that recently targeted a large number of high-profile platforms. The deal also included solutions from our Service Assurance offerings related to the customers' 5G expansion. The cybersecurity and Service Assurance purchases were implemented to improve the subscribers' user experience and to reduce churn among their 5G and Wi-Fi customers. In all, these developments reflect our momentum in executing our long-term strategy. With that, let's move to Slide #8 to review our outlook. Looking ahead, we remain focused on driving product innovation, returning to annual revenue growth and enhancing our margin through disciplined cost management. Accordingly, based on our strong first half performance and our pipeline of opportunities, we are raising our revenue and earnings per share outlook. Tony will provide more details on the outlook in his remarks. As we navigate the second half of the fiscal year, we will continue monitoring the uncertain macro environment while remaining motivated by strong and positive customer feedback, including at our recent Annual Engage Technology and User Summit. We hosted this event in September and showcased our latest solution focused on Observability, AIOps and Cybersecurity. It is clear that our customers rely on our highly curated data to drive improved business outcomes across all ecosystems, which we believe positions us well to capture new opportunities through our differentiated solutions. As always, we are committed to empowering our customers to meet the demands of today's complex digital landscape by delivering mission-critical solutions that address performance, ensure availability and safeguard security. We look forward to sharing our progress with you throughout the remainder of our fiscal year. With that, I will turn the call over to Tony.

Thank you, Anil, and good morning, everyone. Thank you for joining us. I'll start by walking you through the key financial metrics for the second quarter and first half of our fiscal year 2026. After that, I'll share some additional commentary on our outlook for the remainder of the fiscal year, including some color on our expectations for the third quarter. As a reminder, other than revenue and balance sheet information, which is on a GAAP basis, this review focuses on our non-GAAP results and all reconciliations with our GAAP results appear in the presentation appendix. I will note the nature of any such comparisons accordingly. All comparisons are on a year-over-year basis unless otherwise noted as well. Slide #10 details the results for the second quarter and first half of our fiscal year 2026. Focusing on the quarterly performance, total revenue for the second quarter increased 14.6% to $219 million. Product revenue increased 16.9% to $94.7 million, which benefited from the acceleration of certain orders expected in the second half. Service revenue increased 12.9% to $124.3 million, reflecting both underlying growth and favorable timing of maintenance renewals, including some back maintenance that was processed this quarter. Adjusting for these timing benefits across both areas, underlying total revenue growth for the quarter was in the mid-single digits year-over-year, demonstrating solid momentum in our business. The gross profit margin increased 1.7 percentage points to 81.4% in the second quarter, primarily driven by product volume and mix. Quarterly operating expenses increased by 11%, which, as previously disclosed, included the shift of our Engage User Summit into the second quarter compared to the third quarter last year as well as the timing of commissions and variable incentive compensation, all of which are expected to normalize, resulting in a low single-digit increase in operating expenses for the full fiscal year. We reported an operating margin of 26.5% compared with 23.1% in the same quarter last year. Diluted earnings per share increased 31.9% to $0.62. Let's turn to Slide 11, where I'll walk you through the key revenue trends by product lines and customer verticals. As a reminder, revenue presented is on a GAAP basis and all comparisons continue to be on a year-over-year basis. For the first half of fiscal year 2026, Service Assurance revenue increased by 10.1% and Cybersecurity revenue grew by 12.7%. During the same period, our Service Assurance product line accounted for approximately 65% of our total revenue and our Cybersecurity product line accounted for the remaining 35%. Turning to our customer verticals. For the first half of fiscal year 2026, our Enterprise customer vertical revenue grew 12.7%, while our Service Provider customer vertical revenue grew 8.4%. During the same period, our Enterprise customer vertical accounted for approximately 60% of our total revenue, while our Service Provider customer vertical accounted for the remaining 40% Additionally, one customer accounted for 10% or more of our total revenue during the second quarter with no customer accounting for more than 10% of our revenue for the first half of the fiscal year. Turning to Slide 12. This slide shows our revenue split between the U.S. and international markets. For the first half of fiscal year 2026, 57% of our revenue was generated from the United States, with the remaining 43% coming from international markets. Additionally, all geographies grew in the first half of the fiscal year. Slide 13 shows some key balance sheet items along with our free cash flow for the period. We ended the second quarter of 2026 with $526.9 million in cash, cash equivalents, short and long-term marketable securities and investments, representing an increase of $34 million since the end of the fiscal year 2025. Free cash flow for the quarter was $4.3 million. During the second quarter, we repurchased approximately 741,000 shares of our common stock for approximately $16.6 million at an average price of $22.34 per share. We currently have capacity under our share repurchase authorization and subject to market conditions, intend to remain active in the market during the remainder of fiscal year 2026. From a debt perspective, we have no outstanding balance on our $600 million revolving credit facility, which expires in October 2029. As previously disclosed as a Q1 subsequent event, on August 4, 2025, we completed the sale of our entire foreign investment highlighted in past quarters for the equivalent of $11.8 million. The original purchase price was $7.5 million. To briefly recap other balance sheet items, accounts receivable net was $130.2 million, representing a decrease of $33.5 million since March 31, 2025. Days sales outstanding, or DSO, at the end of the second quarter of fiscal year 2026 was 51 days compared with 53 days in the same period in the prior year. The improvement in DSO in the second quarter reflects the timing and composition of bookings. Let's move to Slide 14 for commentary on our outlook. I will focus my remarks on our revenue and non-GAAP earnings per share targets for fiscal year 2026. As Anil noted, our strong first half performance gives us increased confidence in our full year outlook. We are raising our full year expectations for both revenue and non-GAAP diluted earnings per share from what we shared in August on our first quarter earnings call. We now expect revenue in the range of $830 million to $870 million compared with our prior range of $825 million to $865 million. Non-GAAP diluted earnings per share is now anticipated to be in the range of $2.35 to $2.45 compared to our prior range of $2.25 to $2.40. The full year effective tax rate is expected to remain at about 20%, and we are assuming approximately 73 million weighted average diluted shares outstanding, reflecting our first half share repurchase activities. In closing, let me provide some color on our third quarter expectations. Given the acceleration of orders we saw in the second quarter, orders originally expected in the third quarter, we are anticipating third quarter revenue in the range of $230 million to $240 million. We expect non-GAAP diluted earnings per share in the range of $0.83 to $0.88 for the third quarter. That concludes my formal review of our financial results. Before we transition to Q&A, please note that our upcoming IR conference schedule is provided on Slide 15. We will be attending the RBC Global TIMT and Needham Tech conferences in November and the UBS Global Technology and AI conference in December. We hope to see many of you at the events. Thank you, and I'll now turn the call over to the operator for questions.

[Operator Instructions] We'll take our first question from Matt Hedberg with RBC Capital Markets.

This is Simran on for Matt Hedberg. Congrats on the quarter. To start, I just wanted to double-click on the strength that you saw in the quarter. Could you talk a little bit about the acceleration of orders that were originally expected in the second half? And what drove that shift? And then on the Fed piece, that was also great to see. So if you could speak to some of the demand trends there as well.

Well, I think this was always -- when we look at the Fed orders, especially, they are always on the edge of the end of the fiscal year. Sometimes we get it end of the federal fiscal year, which is September. So sometime in the past years also, we get it afterwards. And this time, we got -- we had the reverse effect. And second thing, as Tony talked about, we had some big maintenance order, which was recognized later in the year. And those were the 2 big factors. Tony, anything else you think?

No, those were 2 of the factors that pushed us into the -- exceeds expectations. But it was a strong federal quarter. Some of that, again, was the acceleration of that particular order. And we did see the acceleration, we believe, because they were prepping for the federal government shutdown, so accelerated those orders into our second quarter to be prepared when that shut down.

Got it. Got it. And then just one more for me. On GenAI, could you speak to a little bit about what's been resonating with customers on your AIOps offering and then how Enterprise customers have been leaning into it?

Yes. So I always talk about and you may have -- I mean, in the script, you notice all the time, we use the word differentiation because that's the starting point. Before we say we are better, we have to differentiate and get the year plus out. So what's different for NETSCOUT in the generative AI and observability and AI world is that we have smart data telemetry, which we have never shared outside our own applications in the past because the data lakes and other solutions were not ready to consume it like a company like Splunk, ServiceNow, AWS and things like that. So how we are differentiating is not that we have better algorithms in that area because there are so many available even in open source. We're feeding smart data to algorithms in a unique way so that they have better outcomes. So we are basically using our branding as a smart data company, but that smart data was not experienced by third parties because we were not willing to share the data. So we created a new product called AI sensor, AI Insight, basically, which allows it makes it easier to mix our data with other data set, but more importantly, now they can apply their algorithms, whether it's in the ChatGPT area or any other observability to our data, and that's very unique in the industry.

We'll take our next question from Eri Suppiger with B. Riley.

Congrats on a very solid quarter. A couple of questions. First off, on the 10% customer, can you comment as to whether that was a service provider, federal or enterprise? And then on the threat landscape, you talked about for denial of service. Can you discuss how some of these attacks are evolving and whether your end customers are capable of defending against some of the changes in the attack landscape?

So on the first part, Tony, do you want to cover that?

Yes. So on the first part, the over 10% customer's related to the federal government orders. So it was a channel partner.

Okay. On the second one that -- so when we talk about security area, we believe that DDoS market is underserved. A lot of people are looking at more sophisticated attacks. But the DDoS attacks are much, much more easier to orchestrate and they are getting more sophisticated, but they're still easier to orchestrate and they create a new sense factor. like, for example, a carpet bombing attack, a previous DDoS attack will attack a target or a server. The carpet bombing attack is an evolution of that. It's not that difficult to be orchestrated by botnets, which goes after multiple targets at the same time. So now instead of one server or 10 machines, you have hundreds of machines who have to defend themselves. So that's what is happening in the DDoS area. We believe that the industry is doing a great job outside of DDoS area. But within the DDoS area, it's only relegated to specialists and yet nation state actors and even the university students can orchestrate the DDoS attack. So what we did, Erik, in the last 3, 4 years is as we integrated the Arbor DDoS business into NETSCOUT, we brought our scalable DPI technology to that solution. And that was necessary to deal with these new and more sophisticated DDoS attacks.

And what is the timing of some of this evolution? Is this taking place this year? Is this something that's been just kind of gradually evolving over a few years? And how is the state of the market right now?

So we released an option to our product called Adaptive DDoS last year. And that includes this functionality. One of the reasons it's called Adaptive is that -- and that Adaptive DDoS option is sold as a subscription. And because we will keep adapting every 6 months, a new release to deal with new attacks and people can just take advantage of that with the subscription. So some of the adaptive DDoS revenue is already in this year's numbers. And so the adaptive DDoS is our definition of dealing with these new and evolving attacks on a periodic basis through that option.

We'll go next to Kevin Liu with K. Liu & Company.

I'll add my congrats on the results as well. Just on the impact of the government shutdown, it certainly sounds like it accelerated some orders. I was wondering if you could talk about what's happening with kind of the existing pipeline there, whether deals are essentially paused or if they continue to move forward? And then whether there's any sort of fulfillable backlog that was associated with the government orders secured and whether they would still continue to take those even amidst the shutdown?

Yes. I mean I'll let Anil talk a little bit about his perspective on the government. But with regard to the backlog or fulfillable orders, there was some backlog related to the federal government order. And so we already have that order, and so that's already been fulfilled.

Yes. Overall, I think the shutdown has not affected the nonfederal business and even federal business so far not affected, but we are sort of watching it. And so if you look at the uncertainty in the second half, potential uncertainty is the shutdown. If it lingers on, it may affect -- we are expecting more orders in that from the same customer. And second is the impact of tariff. That situation is still evolving, potential impact of that on nonfederal customers. So those are the things we are watching and continue to be -- see whether that affects anything in the second half.

Understood. And Anil, since you mentioned the tariffs, to the extent those are rolled back, what sort of benefits or would you expect to see either from your existing customer base or even if your own business has been impacted, which I don't think it has?

You said benefit?

Yes. I think, Kevin, we haven't really seen any detriment of it at this point. From a business perspective, as we talked about before, given that a lot of our product comes from Canada, the U.S. and Mexico and right now is protected under the various agreements, we haven't seen an impact from a cost perspective. From a customer perspective, I think what Anil is referring to is if they were to change behavior, but we've heard noise around it, but really haven't seen a large impact.

I think the impact will be like on the end user pricing, not necessarily margin because we sell software, which is very high margin. So the potential impact on certain deals are budgets were set up, let's say, 8, 9 months ago. We have long sales cycles, 6 to 12 months. And now if the tariff affects the total price of even the hardware portion, which is they're buying it, then we may have to just make them whole. But it's just all up in the air right now, and we just need to watch.

And Kevin, just on the federal government, we do have a strong pipeline opportunity with the government, the federal government orders. And so we continue to look at that. I think we're a little bit insulated in the near term because of the pull forward of orders as they prep for the shutdown. So we'll continue to watch that.

Got it. And just lastly, if I could ask about your product gross margin, that's as high as I've seen it before. Is there anything in terms of how you guys are going to market or which products are in demand from customers right now that's contributing to that? And how sustainable do you think this level is?

Well, I think the biggest part is that we are generally counting on selling our AI. And so we have 2 segments, as you know, the core business, DDoS and Service Assurance. The AI solution will be marketed to the Service Assurance customers. Largely that, I mean, less than 10% will be new customers. And Cybersecurity solution, which we call it Omnis Cybersecurity will be marketed to DDoS customers. So we are looking at these products as sort of adjacencies to the existing product line and yet attracting new budgets. So that's a good situation, and we don't need to hire a lot of salespeople or train them to do that yet we have new opportunities.

Yes. And so I'd say, Kevin, for the quarter, our product gross margin was in the high 80% range, where it's typically in the mid-80% range. And it was particularly strong given the volume of software sales in the quarter. And in the future, we're continuing to move more and more to software-related type sales.