Andrew M. Kramer - NetScout Systems, Inc. Anil K. Singhal - NetScout Systems, Inc. Michael Szabados - NetScout Systems, Inc. Jean A. Bua - NetScout Systems, Inc..

Mark Kelleher - D. A. Davidson & Co. Alex Kurtz - Pacific Crest Securities Chad Michael Bennett - Craig-Hallum Capital Group LLC Matthew George Hedberg - RBC Capital Markets LLC Eric Martinuzzi - Lake Street Capital Markets LLC Kevin Liu - B. Riley & Co. LLC.

Ladies and gentlemen, thank you for standing by and welcome to NETSCOUT's Fourth Quarter and Fiscal Year 2017 Results Conference Call. At this time, all parties are in a listen-only mode until the question-and-answer portion of the call. As a reminder, this call is being recorded.

Andrew Kramer, Vice President of Investor Relations and his colleagues at NETSCOUT are on the line with us today. I would now like to turn the call over to Andrew Kramer to begin the company's prepared remarks..

Thank you, Neal, and good morning everyone. Welcome to NETSCOUT's fourth quarter and fiscal year 2017 conference call for the period ended March 31, 2017.

I'm joined today by Anil Singhal, NETSCOUT's Co-Founder, President and CEO; 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, which can be accessed on the Investor Relations section of our website at www.netscout.com. You can advance the slides in the webcast viewer to follow our commentary. We'll try to call out the slide number we're referencing in our remarks.

Today's agenda will be consistent with prior quarters. Our CEO, Anil Singhal, will share his perspective on our results, key trends and highlights, and our outlook for fiscal year 2018. Our COO Michael Szabados will briefly highlight notable go-to-market activities and key wins.

Our CFO Jean Bua will then provide greater detail and insight into the financial results, and review our fiscal year 2018 guidance.

Moving on to slide number 3, I would like to remind everybody listening that forward-looking statements as part of this communication are made pursuant to the Safe Harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended, and other federal securities laws.

Investors are cautioned that statements in this conference call, which are not strictly historical statements, including but not limited to, the statements related to the financial guidance and expectations for NETSCOUT, market conditions and customer demand, and all of the other various product development, sales and marketing, expense management, integration and other initiatives planned for fiscal year 2018 and beyond, constitute forward-looking statements which involve risks and uncertainties.

Actual results could differ materially from the forward-looking statements due to known and unknown risks, uncertainties, assumptions and other factors. This slide details these factors, and I strongly encourage you to review each and every single one of them.

For a more detailed description of the company's risk factors, please refer to the company's Annual Report on Form 10-K for the fiscal year ended March 31, 2016 and subsequent quarterly reports on Form 10-Q, which are 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 number 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.

This slide, which we also encourage you to read, provides information about the use of non-GAAP and GAAP measures because non-GAAP measures are not intended to be superior to, or a substitute for, the equivalent GAAP metric.

Non-GAAP items are described and reconciled to GAAP results in today's press release and they are included at the end of the slide presentation that's made available online on our website.

As a reminder, the acquisition of the Danaher Communications Business was completed on July 14, 2015 and as such, the results for the full fiscal year 2017 are skewed in comparison with fiscal year 2016.

To provide an apples-to-apples comparison between these two fiscal years, we have provided additional non-GAAP, pro forma details so that you can better understand the key performance trends as well as gain further context for our fiscal year 2018 guidance.

Reconciliations between the GAAP and non-GAAP pro forma financials are provided in the presentation's appendix. As we detailed in our press release today, we delivered a strong finish to the fiscal year and achieved the key financial and strategic milestones we laid out at the start of the year.

We continued to make good progress on fortifying our incumbency in key accounts and on delivering on our new product cycle. With that as a high-level background, I'll turn the call over to Anil to provide some further context on our non-GAAP results, recent achievements and our outlook for the coming fiscal year. Anil, please go ahead..

Thank you, Andy. Good morning everyone, and thank you for joining us. Let's begin on slide 6 with a recap of our recent results.

We enjoyed a solid finish to the quarter that enabled us to achieve our fiscal year 2017 targets with non-GAAP revenue of $1.2 billion, a gross margin of 75.2%, an operating profit margin of 23% and diluted EPS of $1.92 per share. Jean will review our performance in more detail, but I'll share a few brief observations.

Total revenue was essentially unchanged from the prior year's on a pro forma basis. In the service provider vertical, exceptionally strong revenue growth within our Arbor security product area was offsetted by the decline in our service assurance product area.

Excluding one of our Tier 1 service providers who delayed larger orders during the second half of the year, we were encouraged that NETSCOUT's service assurance revenue grew by double digits.

In enterprise, mid-single-digit growth of our nGeniusONE solutions and mid-teens growth at Arbor was offset by declines within the legacy Fluke enterprise product lines arising from product rationalization and the ramping of new manufacturing and distribution channels.

We have put these issues behind us and expect any related impact to be minimal in fiscal year 2018.

Overall, our cybersecurity product area was a standout performer with exceptional growth that reflected the combination of a surge in capacity expansion initiatives and new customer wins following highly publicized, advanced denial-of-service attacks and a spike in service provider spending related to a transition in product offerings.

In terms of profitability, we delivered our second consecutive year of 200 basis points of operating margin improvement. We have continued to solidify our market and technology leadership in both verticals. We have fully integrated the key assets we acquired from Danaher and we have made excellent progress on our new product cycle.

Our innovations are aimed at further elevating our value proposition to customers and helping drive ROI on their technology infrastructure by protecting their networks from attacks, resolving network and application issues faster, and more efficiently advancing digital transformation initiatives with confidence, and using our data to make superior technical and business decisions.

Let's move to slide number 7 to cover this progress. This slide helps illustrate our progress since acquiring the Danaher Communications Business nearly two years ago, and frame it against our outlook for fiscal year 2018.

Over the past two years, we have expanded our operating margin by more than 400 basis points, while maintaining the revenue lines and addressing a range of integration challenges.

We have diligently managed our cost structure, retained key talent and invested in a major expansion of our product line through both organic innovation and by integrating various acquired assets which we have acquired. As we move into fiscal year 2018, we expect to, once again, improve our operating margin by another 200 basis points.

We plan to achieve this largely by moving to higher software content in our products, which will also bring higher gross margins. In the service provider sector, 4G and LTE technology is now a mainstream deployment, enabling a significant rise in OTT traffic from 4G subscribers that's straining their infrastructure and associated CapEx.

At the same time, revenue growth is proving elusive for mobile operators, partly due to competitive all-you-can-eat calling and data plans, and that is forcing them to limit their capital spending.

This has created headwinds that all vendors have been navigating for the past couple of years, and we anticipate continued near-term spending challenges, particularly with certain Tier 1 service providers in the U.S.

In such an environment, delivering a lower-priced software solution for service assurance use cases without compromising the associated value is becoming increasingly appealing to major service providers.

We recognized this opportunity some time ago, and we have been evolving our solution for service providers through a software strategy that can help these customers maximize the utilization of their service assurance budgets, while also enabling us to solidify our incumbency, gain greater top line certainty via multi-year deals, and win new business in a price-sensitive market while substantially increasing our gross margins.

Our new InfiniStreamNG or InfiniStream next-generation platform, is now available in software form and combines the best features from the legacy NETSCOUT and former TekComms platforms. We have made excellent progress thus far with this new software strategy with our carrier and cable customers on multiple fronts.

Last quarter, we announced a five-year, $75 million deal with a U.S. Tier 1 carrier who is using NETSCOUT technology to consolidate its service assurance vendors and gain more pervasive visibility. Yesterday, we announced another significant multi-year agreement with the Vodafone Group in Europe.

Under this multi-year agreement with Vodafone, NETSCOUT will serve as Vodafone's exclusive service assurance solutions provider across 13 countries in Europe.

By working closely with Vodafone to understand its long-term network plans, we have structured an agreement that enables them to enjoy the benefits of a standardized, repeatable service assurance solution across Europe, while efficiently and pervasively deploying our InfiniStreamNG software on commercial off-the-shelf, COTS, appliances.

This milestone agreement has fortified our relationship with Vodafone and further showcases the unequivocal market appeal of our new InfiniStreamNG platform in the software-only form factor. We have already started shipping software to Vodafone under this agreement, and look forward to supporting broader adoption of our solution going forward.

Over the coming years, we believe that this deal will generate healthy, consistent revenue levels, accelerated sales cycles, and create new opportunities for NETSCOUT. Looking ahead, we are confident that there'll be many more service providers who will deploy our software in fiscal year 2018.

Based on the deals that we have already completed, we believe that the software-only version of our InfiniStreamNG could represent between 8% to 10% of product revenue in fiscal year 2018, and we are aggressively pursuing a range of opportunities to further expand the contribution from this platform.

(11:55) Overall, we continue to see attractive opportunities for growth in our enterprise service assurance and cybersecurity product areas, as we expand the breadth and depth of our product portfolio.

By executing well on these fronts, we believe that we can drive high single-digit to low double-digit growth in the enterprise, and mitigate an anticipated decline in the service provider vertical as we accelerate the transition to our software-only solution with service providers.

Our goal is to exit the year in an excellent position to resume top-line growth in fiscal year 2019 and beyond, while continuing to enjoy further gross margins and operating margin expansion.

Moving on to slide 8, NETSCOUT is focused on delivering true business assurance to our global customer base by addressing their service assurance and security assurance requirements.

As a reminder, the basis of our technology platform is our patented Adaptive Service Intelligence technology, or ASI, that converts network traffic data or wire data into structured metadata or smart data in real time.

ASI is enabling us to deliver an expanding range of analytics, spanning network, application, and infrastructure performance management, cybersecurity, and business intelligence. As you may recall, the first proof point of our integration effort occurred last summer, when we introduced our new InfiniStreamNG real-time information platform.

This platform is available in multiple form factors, from traditional appliances to software for use with COTS servers that the customer procures, and in virtualized form to monitor private and public cloud environments, as well as virtualized network functions and traditional IT server farms.

As I have detailed, service providers are increasingly recognizing that deploying our InfiniStreamNG software can help them instrument (13:57) deeper into their network infrastructure and, in the process, open new doors for us around our newest capabilities spanning NFV, IoT, video monitoring, radio access networks, and big data analytics.

Our big data analytics solutions, for example, will be generally available to service providers later this quarter. In the enterprise, we are advancing three exciting new product initiatives that we believe will help us build on our momentum.

First, later this month, we plan to launch new solutions that enable organizations to confidently migrate applications and workloads to private and public clouds, as well as gain increased visibility into traditional physical and virtual server farms.

Second, we plan to add complementary, new capabilities for infrastructure performance management or IPM.

This offering, which will be introduced within the next several months, will enable customers to leverage their nGeniusONE investments to monitor the performance of software-as-a-service applications, network devices and servers rather than spending heavily on dedicated third-party IPM tools.

Third, we are also advancing product integration and cross-selling between Arbor and NETSCOUT sales teams. Later this summer, we plan to integrate our InfiniStreamNG with Arbor's Spectrum advanced threat analytics, which help enterprise security teams to quickly and accurately detect and confirm hidden threats.

We also plan to leverage our enterprise service assurance sales force to market Spectrum into our installed enterprise customer base, while also taking advantage of NETSCOUT's historically strong federal presence to sell both Spectrum and our DDoS solutions to government agencies.

We are very excited to bring all these new products and capabilities to the marketplace, which brings us to slide number 9 for our outlook. As we move into fiscal year 2018, we look forward to delivering another good year of improved profitability and EPS growth.

More specifically, we anticipate that accelerating the transition to our new software platform will help increase gross margins by 1 to 2 percentage points and serve as the primary driver for operating margin growth in fiscal year 2018.

While we are excited about the potential of our newest products, we are taking a relatively cautious view on their contribution this year since many of them have yet to be officially launched and it will likely take at least a few quarters for them to gain significant traction.

Consistent with prior years, we expect to generate the majority of revenue and profits in the second half of the fiscal year. Finally, I would like to thank my colleagues across NETSCOUT for their efforts in fiscal year 2017 and for their unwavering commitment to delivering world-class products and support to our customers around the globe.

That concludes my remarks. I would like to turn the call to Michael at this point for his commentary..

Thank you, Anil, and good morning everyone. Slide number 11 outlines the areas that I will cover. As you may know, we begin every fiscal year with our annual Sales Kickoff event and our Engage User Conference.

This year's Engage had record attendance with CIOs, CSOs, and senior-level network, cybersecurity and line-of-business professionals from over 300 organizations representing every major vertical as well as NETSCOUT distribution partners.

It was invigorating to see the enthusiasm of our sales teams and our customers for our newest products that are being delivered according to the timetables that we laid out for them last year. We see our smart data technology becoming even more important to our customers as they advance their digital transformation projects.

I will integrate some of the feedback we received from our customers at Engage as I review several notable wins.

Our carrier and cable customers at Engage were impressed by the way that we brought together the former TekComms and NETSCOUT technologies to provide a seamless user experience, while enabling them to access next-generation analytics and cost-effectively expand their visibility via the software-only version of our real-time information platform.

This is exemplified by our recent win with Vodafone, and I look forward to sharing details of another software-only win in the Asia Pacific region next quarter. In the enterprise, we closed approximately $3 million in orders during the fourth quarter with a global payments technology leader in support of multiple projects.

One of this longstanding customer's orders was for consolidating their service triage tools by standardizing on our nGeniusONE platform and moving away from a dual-sourced vendor strategy that had included Riverbed's Opnet products.

Another order involves the build-out of two new next-generation data centers using the latest SDN and private cloud technologies.

Customers like this understand that they cannot afford to be blind to issues impacting the performance of mission-critical applications, regardless of whether the applications or their various components run in legacy data centers or in the private or public cloud.

That's why there was genuine excitement at Engage about the upcoming launch of our new server-based ASI software instrumentation, which seamlessly extends our monitoring and diagnostic workflows to applications running on on-premises physical and virtual servers and to applications running in hybrid, private and public cloud environments.

There was also strong interest from customers seeking to learn more about our new infrastructure monitoring and diagnostic product, which will cost-effectively simplify and accelerate root cause analysis by adding device metrics, syslog and synthetic test results derived from the infrastructure itself to our ASI dataset.

Turning to cybersecurity, Arbor delivered an impressive close to an exceptionally strong year. One of Arbor's major highlights was winning one of its largest enterprise orders ever from a major international information services company.

This order was over $5 million and grew in scope as the customer recognized the need for global protection against the types of advanced DDoS attacks that have been making front-page news recently.

They selected Arbor based on its extensive expertise, global coverage and proven set of products and services that safeguard against both sophisticated application-layer attacks and volumetric DDoS attacks.

At Engage, we showcased our products to further increase the network and scrubbing capacity in our Arbor Cloud DDoS service and continue enhancing our product portfolio with more software-driven options.

Our service assurance enterprise customers were also intrigued by the way we can help them leverage their investment in NETSCOUT technology by using the Arbor Spectrum analytics with our InfiniStreamNG as the source of packet data.

This unique combination can make a tangible difference in finding and isolating advanced threats faster, thereby improving the effectiveness of existing security staff by up to 10 times.

In summary, we are pleased with the way we finished the fiscal year 2017 and are moving forward focused on a range of sales and marketing initiatives that are aimed at maximizing the impact from this new product cycle over the longer term. That concludes my prepared remarks and I will turn the call over to Jean..

Thank you, Michael, and good morning everyone. This morning, I will review key fourth quarter and full-year metrics for fiscal year 2017. After that I will review the guidance for fiscal year 2018.

As a reminder, this review will focus on our non-GAAP results, and comparisons between fiscal years 2017 and 2016 are on a pro forma basis, unless otherwise noted. Slide number 13 shows our results for the fourth quarter of fiscal year 2017.

As we've previously discussed, we anticipated a large order from one of our service providers that moved from the third quarter of fiscal year 2017 into the fourth quarter, and then it actually moved out of fiscal year 2017. Despite that delay, our teams around the globe worked diligently to be able to achieve our annual financial targets.

For the quarter, total revenue increased 6% to $327.2 million, our operating profit margin was 27.5% and our diluted earnings per share was $0.65 per share. For the quarter, income from operations grew approximately 30% on revenue growth of 6%.

This performance illustrates the operating leverage that can be achieved as we execute on our strategy since we believe we have already made the necessary investments in our R&D and go-to-market teams that are focused on building our positions across all segments of our total addressable market.

Turning to our full-year results on slide 14, our total revenue was comparable to the prior year's total revenue. Service revenue grew by 2%, while product revenue declined by 1%.

Our gross margins improved slightly as favorable shifts in product mix more than offset the impact of long lead-time projects involving lower-margin legacy products from the former TekComms product area. Operating expenses declined more than 3% over the prior year due mostly to reductions in personnel-related costs.

Our operating margin improved by 200 basis points to 23% on relatively flat revenue. Our effective tax rate for the year on a non-GAAP basis was 32.6%, which reflects the benefit of taking advantage of certain foreign tax credits, including some for prior years that were applied retroactively.

The lower effective annual tax rate contributed about $0.02 to our earnings per share. For the fiscal year 2017, our net income was $178.5 million. Slide 15 shows our two customer verticals, service provider and enterprise, from a revenue performance perspective and a revenue composition perspective.

Despite the spending pressure facing many of our largest service provider customers, our overall service provider vertical remained relatively flat on a year-over-year basis. Within this vertical, our service assurance product area declined about 10% due to the delayed spending by one of our large Tier 1 providers.

Excluding this service provider's revenue from both years, our service assurance portion grew by about 25%. Additionally, within the service provider vertical, our cybersecurity revenue increased by about 40%. A major driver of our cybersecurity growth was tied to a transition in product offerings.

Without this product cycle transition, revenue growth would have been in line with the market growth of low double-digits, as DDoS became a higher priority item for both new and existing customers following high-profile attacks this past fall. Turning toward the enterprise vertical, overall revenue increased by about 0.5%.

Within this vertical, our legacy nGeniusONE revenue grew by 5%. We grew 12% across all non-federal government and commercial sectors, including financials. This growth was partially offset by a decline in the federal sector, which is common in an election year.

Our cybersecurity products grew by 14% due to heightened awareness of vulnerability to DDoS attacks. As previously noted, the nGeniusONE and cybersecurity growth was offset by a decline in the former Fluke product areas of about 17%, due to both product rationalization and the transition of manufacturing and distribution channels.

Regarding the composition of the revenue, in fiscal year 2017, service provider represented 56% of total revenue, with enterprise representing the balance. This is unchanged from the prior year. Slide 16 highlights revenue by geography, which is calculated on a GAAP basis.

For fiscal year 2017, our international business represented 37% of total revenue, versus 30% in the prior year. Our revenue from international markets grew about 28% on a year-over-year basis, with all geographies contributing.

This growth primarily reflects the completion of certain long lead-time legacy projects within our international service provider vertical, along with higher demand from overseas operators due to the combination of 4G becoming more mainstream in certain geographies and the build-out and further expansion of 4G infrastructures in emerging markets.

Slide 17 details our balance sheet highlights and free cash flow. We generated free cash flow of $195.7 million in fiscal year 2017. Excluding exceptional items and one-time events tied to the Danaher transaction, our normalized free cash flow was approximately $165 million for fiscal year 2017.

This represents a free cash flow conversion to non-GAAP net income of about 92%. For the fiscal year 2018, we believe that free cash flow conversion to non-GAAP net income should be about 100%.

As it relates to our financial profile, with $500 million of credit available on our existing facility and the higher level of cash on the balance sheet, our liquidity now stands at $965 million, and our gross leverage remains at the lower end of our target range.

In terms of our share repurchase activity, we repurchased 21,000 shares of our common stock this past quarter. For the second consecutive quarter, the strong, swift rise in our stock price limited our repurchase activity under the parameters that were approved by the board and put in place shortly after announcing last quarter's results.

For the year, we purchased approximately 3.1 million shares at an average price of $25.41 for a total consideration of $80 million, or roughly 45% of our adjusted free cash flow. At present, we have approximately 6.8 million shares remaining on the 20 million shares authorized for repurchase.

With significant cash on hand and modest debt, we believe we have sufficient resources to meet our capital deployment priorities. Returning excess cash flow to shareholders through our share repurchase activities continues to be a high priority, and we expect to be active in the market during the first fiscal quarter of fiscal year 2018.

As the two-year anniversary of the Danaher Communications Business acquisition approaches, we are working with our board to review our financial policies, which includes our share repurchase program. We appreciate the feedback and perspectives that our shareholders have shared with us on this matter.

To briefly recap other balance sheet highlights, accounts receivable, net, increased by 19% from the end of the last fiscal year as a result of overall product mix shifts and the timing for service renewals. DSOs were 80 days, which is unchanged from this time last year, and down slightly from 83 days in the third quarter.

Let's move to slide 18 for guidance. The reconciliation of our GAAP guidance to our non-GAAP guidance is in the appendix. Based on our current pipeline of opportunities, we expect that our fiscal year 2018 revenue will be relatively unchanged from fiscal year 2017 levels.

As Anil discussed, ongoing adoption of our software-only platform is expected to play an important role in improving our gross margins in fiscal year 2018 and delivering a 200-basis point improvement in operating profitability over last year, to 25%.

Correspondingly, we are targeting diluted earnings per share growth over last year that will range from the mid to high single digits. As a reminder, and consistent with prior practices, our earnings per share guidance does not yet reflect any share repurchases.

As is our practice, we will update the EPS guidance range based on the share repurchase activity. Supporting our overall view on revenue is the expectation that we will drive strong high single-digit to low double-digit percentage growth in the enterprise customer vertical.

This reflects ongoing momentum for our nGeniusONE product suite, and attractive growth prospects within our cybersecurity offerings, while taking a conservative view on the contribution from the slate of new products that are coming to market soon.

We currently anticipate that this growth will be offset by an expected top-line decline in the high single-digit percentage range in our service provider vertical that primarily reflects continued near-term spending delays, particularly with certain Tier 1 service providers in the U.S.

In terms of the phasing of our quarterly revenue, we expect the majority of our revenue and profits to be generated in the second half of our fiscal year, which is consistent with the company's historic performance. More specifically, we have traditionally generated around 45% of total revenue in the first half of the fiscal year.

We currently anticipate a more muted start to the year, with around 40% of fiscal year 2018 coming in the first half and a high-teens contribution from our first quarter. This would translate into a year-over-year decline in the first quarter's revenue in the high teens on a percentage change basis. This view primarily reflects two factors.

First, the year-ago quarter included significant orders from a Tier 1 service provider. We expect revenue from that same customer this quarter to be lower by around $35 million to $40 million as they delay larger-sized purchases. This dynamic, combined with a difficult comp at Arbor, will contribute to a tough quarter in service provider.

And secondly, although we are launching many new products within the enterprise vertical, we anticipate that the pipelines will still be in development with initial revenue beginning to be recognized in the second half of the year.

In terms of our cost structure, we plan to maintain relatively flat operating costs across the board for the full year, and anticipate that first quarter expenses will be down in the mid-single-digit percentage range over the prior period.

For other modeling assumptions, we expect interest and other expense to be between $10 million to $12 million for the year, and we currently anticipate a full-year tax rate between 33% to 34%. Based on approximately 93 million shares outstanding, this would translate into a diluted earnings per share range for the first quarter of $0.05 to $0.08.

That concludes my formal review of our financial results. Before we transition to Q&A, I'd like to emphasize our ongoing commitment to proactive outreach with our shareholders. Slide number 19 highlights the various investor conferences we plan to participate in over the next couple of months. That concludes our prepared remarks this morning.

Thank you again for joining us and we're now ready to answer questions. Neal, you may begin the Q&A session now..

We'll take our first question from Mark Kelleher of D. A. Davidson. Your line is open..

Great. Thanks for taking the questions. I wanted to look at Arbor a little closer. You mentioned there was a large deal – I think you mentioned there was a large deal in the enterprise area.

Is there a way you can give us an idea of what percent of Arbor right now is enterprise versus service provider?.

It's about – enterprise versus service provider in Arbor's revenue is about 65% service provider and 35% enterprise..

Okay. And as a follow-up, that growth there seems to be offsetting some weakness at Fluke which is, if I understand is enterprise.

Where are we with the Fluke transition? Is that still a headwind or has that bottomed out?.

I think as we talked about, Mark, it has bottomed out now and I think we are beginning to see an uptick and we don't see any real impact on this – negative impact on this in the coming years..

Okay. Thanks..

Sure..

Thank you. We'll take our next question from Alex Kurtz of Pacific Quest (sic) [Pacific Crest] (35:25). Your line is open..

Yeah. Thanks.

Can you guys hear me okay?.

Yeah..

Yeah..

Yes. Good morning.

So, the high-single-digit declines in service provider, Anil, if I heard that right, what percentage of that is being driven by just overall spending in that vertical versus transitioning some of your customers to software-only? I think you said 8% to 10% of the business this year will be software-only, but I guess what's that percentage – as a follow-up, what's that percentage in the service provider segment?.

I'll let Jean add maybe a specific percentage, but overall software strategy is that we need to mitigate part of the OpEx and CapEx challenges. So, everything is related to dealing with OpEx and CapEx. We just decided that instead of market forces disrupting us, we rather do it ourselves proactively.

And so that's what is resulting in 10%, we are – that number we are forecasting for this year, it was low single digits this year. And next year, we hope that we'll accelerate that beyond 10% and that will result in even better gross margins. But overall, dynamic playing in the sector is that customer has X amount of budget.

And unless they can buy sufficient capacity for an X amount, they rather not do anything or do go to cheaper solutions, less attractive, but cheaper solutions. And by we coming up with a software solution and it's evidenced by the couple of (37:06) we announced, the decisions (37:10) have been possible without the software solution..

Okay.

And, Jean, the Arbor growth at 14% in enterprise, was total Arbor growth approximately that kind of rate or is it – maybe it was higher because of the service provider?.

Yes, the Arbor service provider growth was 40% as we talked about and then it was 14% in enterprise. So, when you blend that together, they came close to a 30% growth rate. And as I mentioned in our prepared remarks, they had a product transition, that is one of the reasons why their growth rate is so far ahead of the market rate.

The market generally grows anywhere from 12% – 10% to 12% and Arbor, when you normalize for that product transition, actually grew a little faster still than the market in 2017, probably mostly due to some of the high-profile events that happened in DDoS and a lot of customers come forward realizing that they have vulnerabilities and then they turn to Arbor..

I think I just wanted to point out one interest – additional dynamic for all the audience as it may not be clear. I mean, there are three ways to sell the Arbor product, direct sale to enterprise, direct sale to service provider and selling to service provider so that they can be a channel for the enterprise.

So, that makes the – it's very difficult to take the service provider number and say how much was real enterprise because that service provider includes not only the stuff they're consuming for themselves, but what they are using it as selling as a service and it's just hard for us to separate ourselves.

That's why it looks – service provider number look higher than that actual..

And, Alex, just to make sure that everybody's clear, that 8% to 10% contribution for the software platform is on a – as it relates to product revenue, not total revenue..

We'll take our next question from Chad Bennett of Craig-Hallum. Your line is open..

Great. Thanks for taking my questions this morning..

Sure..

So, Anil, can you maybe talk about kind of the software transition that you're seeing within service provider? Maybe how the magnitude of the transition from roughly a year-ago period and kind of how your thoughts have changed there. And then maybe you can chat about your competitive strength in a software-only world in the service provider space..

Yeah. So, I think we were – NETSCOUT was always a software company. We just ship most of the software with bundled hardware.

TekComms, on the service provider side, was primarily a hardware-based company, custom hardware and that affected, obviously, their gross margin and the combined margin of the company in the service provider sector after the acquisition because they were a bigger dominant portion of the revenue.

So, what we saw last year was that we have the best solution and we were the number one and number two player and combined, we have 50% market share and everyone wants to use our solution, but they were looking for two things.

They were looking for a better price because of their budget challenges and they were looking for the best of both features in a single product. And that was the number one initiative for the company which is why it (40:55) started almost 18 months ago. And so that's what we have delivered now.

We've delivered phase one of that last year, which was a software solution, but with only NETSCOUT technology and we just are starting to deliver now the combined solution in the software form.

And I think that's creating the best of both worlds for the customer or best of three worlds in the sense that, they're getting the best three technology from the two companies in a single platform.

They're able to have a price point, which fits their budget and software model reestablishes the incumbency for us, so that we can sell other optional things in the future as we move to video analytics and other areas..

Right.

And then, Anil, can you give us an update on your thoughts on both timing and relative impact of 5G on spend to you guys?.

I think we see a very small impact of 5G, but there is an indirect impact on our 4G solution because of the software strategy. So, as people are looking for 5G solutions, they will traditionally look for incumbents who can satisfy their needs both from a budget and a value perspective.

So, moving to a software model, the dynamic I just described, allows us to be the number one player in the 5G area, but it's not going to really impact – have any meaningful impact on the revenue in the coming years..

Our next question comes from Matt Hedberg of RBC Capital Markets. Mr. Hedberg, your line is open..

Hi guys. Yeah, thank you. Sorry about that. You guys have talked about getting gross margins back to their historic levels of, I think, near 80%, versus kind of mid-70%s today.

I guess, including the release of InfiniStreamNG, can you outline and maybe rank the other opportunities for gross margin expansion?.

I'll let Jean maybe add to this. But I think the biggest opportunity is because InfiniStreamNG has become the combined platform for TekComms and NETSCOUT moving forward, and it's available in the software and appliance versions.

And so margins are already increasing even with the appliance version, because it's higher gross margin than the TekComms' custom hardware version. But we think that this will allow us to reach our 80% gross margin target sooner than we would have thought earlier, and maybe even exceed it in the future.

Jean, anything else?.

Sure. As we've talked about in the past, Matt, if you went through the different products that we have, the cybersecurity product already achieved a margin higher than 80%, and the legacy NETSCOUT products were probably a little higher than 80% also. And then when you move to software-only, that would have probably a 90% or greater margin.

So, as we talked about in the past, those products, and those are the products that we're really driving, should help to improve the gross margin. Some of the legacy products, like some of the Fluke product, systems product, and some of the software related to Tek, also gets integrated to the InfiniStream.

The drag on margins from those two product areas should dissipate over FY 2018 and then further into 2019 and 2020..

That's great. And then maybe as a follow-up, your security business is doing well.

I'm curious, with your international exposure, are you seeing any benefits from the European breach notification? Or is it hard to sort of quantify the benefit of that?.

Yeah. I'm not directly familiar with this. But overall our, I mean, international business is a very big portion of the security business compared to the service assurance business.

So I think that DDoS solution, which is sort of universally applicable, has bigger budgets allocated on the international side than what we see in the service assurance side..

Thanks, guys..

Yeah. Thank you..

Thank you..

We'll take our next question from Eric Martinuzzi of Lake Street Capital Markets. Your line is open..

Yeah. I just wanted to sharpen my pencil here on the Q1 guide. If we start with the $278 million of non-GAAP revenue in Q1 of 2017 and we're decrementing that, you said high teens, just because of this abnormal skewing here in FY 2018. I'm coming up with about – if I use a minus 16%, I'm coming up with about $234 million.

Is that a correct algebra exercise for Q1?.

Hi, Eric, it's Jean. I just would quibble on the definition of high teens, I would say high teens would probably be closer to 18%, 19% rather than more of a mid teens, 16%..

Okay, all right. Given that substantial drawdown, I'm looking at an EPS decrement of a similar percent versus the $0.28 a year ago.

Is that fair? Or is there enough of an offset on the gross margin/OpEx, too?.

No, I think that decrement is probably – I think the decrement flows through and, in our prepared remarks, we said we anticipated that the earnings per share for the first quarter would be anywhere between $0.05 to $0.08..

Okay. All right. And then, shifting over to the Vodafone win. By the way, congratulations to (47:15) renewal/expansion there. You characterize the win as kind of them choosing you because of the ability to standardize and do something repeatable.

I think, if you could go a layer deeper there, it might help me get an appreciation for some competitive advantages of you versus other providers..

So I think, when you look at the service assurance, which is the biggest portion of the revenue for the company and, even within service assurance, service provider is the bigger portion for us.

So, standardized means that we are the exclusive provider of service assurance solutions and there is no competition in that, and we have – and the standardization also means that, obviously, we have to continue to deliver great service to them, which we're counting on.

But otherwise, standardization means that, every time we take an order, there is no price negotiation, there is no contract or anything, it's basically just order. We have a price for our product negotiated based on this deal, and we just order, just from this thing. They don't need to go to various places.

As long as they have budget, they don't have to go for approval. So, it makes the process much simpler. So, we have to continue to watch out for other things which we can do beyond service assurance. But overall, (48:48) competitive and as we move to 5G virtualization and other areas..

Hi, Eric, this is Jean. Just to add on, Vodafone is a architectural decision that's coupled with our functionality and ease of management.

And it is an example of the product suite that we have where we can go in the case of a service provider from the RAN, which should help us in 5G all the way to the data center which – where our service assurance products have been heavily invested and also in analytics and to the cloud when it comes to enterprise.

So, we see the Vodafone win as being able to standardize on vendors also and being able to consolidate the tool (49:30) vendors that a lot of our customers struggle with..

We'll take our next question from Kevin Liu of B. Riley and Company. Your line is open..

Hi, good morning..

Hello..

Just regarding the service provider deal that slipped out of the back half, are you guys still factoring that into your guidance for the current year? And maybe more generally just from the larger Tier 1 customers that you've had traditionally, what's sort of the expectation baked in for the declines over there over the course of 2018?.

Hi, Kevin, this is Jean. I would say that we are – they've been a long-term customer and we're on negotiations and discussions and relationship management with them. As you know from reading the headlines, a lot of these customers have been hit lately with the all-you-can-eat plans.

So, it's caused them to stop and really look at their overall spending. So, I would say today that is really the situation that we're in with this particular Tier 1.

So, while we don't anticipate at this point any large orders in the current quarter, we are hopeful that they will be continuing to see the value that we've provided to them and continuing to place orders with us over the next three quarters or so. Actually, just to add on one comment.

We're also talking to all of the Tier 1s as it comes to our software-only solution.

So, if there's any – as Anil talked earlier, where their budgets are being constrained due to their own economics where we have the software-only appliance also, we can give them a price point that more aligns with what their CapEx needs are or OpEx needs today, but continue to provide them with excellent service..

Got it.

Actually that ties in well with my follow-up, which is just in terms of the software-only deals, how does kind of the amount of spend you're getting from these customers compare with what they might have traditionally? Or are these really targeted more so at kind of new potential accounts that you haven't touched previously?.

I think there are three numbers – this is a very common question people are asking, what it could have been and nobody knows what it could have been. I think clearly, if they were to buy the same amount of product from us four years ago at the height of LTE spending, the numbers will be significantly larger.

But the reality is, we didn't have a software solution, we will not get what we are getting.

So, I think this is a short-term disruption, I call it short-term pain, long-term gain, it's a blessing in disguise because ultimately it'll promote one of the best solution in the industry, which is ours to be more progressive in the enterprise and service providers. Even the software solution could eventually be used in the enterprise also.

And this will allow us to deliver more value at a reasonable price to the customer. So, that's how I look at it. I think if you compare apples-to-apples, yes, it's significantly lower price for the same amount of product or same amount of coverage versus three years ago, but that's not the right metrics.

It is the metrics, what would happen if we didn't have a software solution. And I think the situation will be really bad and will be affecting both gross margin, top line and operating margins. Now we are able to improve gross margin, operating margin, keep the revenue line intact and then grow from that base moving forward..

Understood. Thank you for taking the questions..

And there are no further questions at this time..

Great. Well, thank you very much, operator, and thanks to our analysts and shareholders and investors for listening into today's call. Hope to see you out on the road over the next couple of months. And certainly, if you do have any follow-up questions, feel free to send an e-mail to Investor Relations or give me a call. Thank you all very much..

This does conclude today's NETSCOUT's fourth quarter and fiscal year 2017 results conference call. You may now disconnect your lines, and everyone have a great day..