Netscout Systems Inc (NTCT) 2017 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to NetScout's Fourth Quarter and Fiscal Year 2017 Results Conference Call. (Operator Instructions) 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. (Operator Instructions)

I would now like to turn the call over to Andrew Kramer, to begin the company's prepared remarks.

Thank you, Leo, 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 and President and CEO; Michael Szabados, NetScout's Chief Operating Officer; and Jean Bua, NetScout's Executive Vice President and Chief Financial Officer.

There's a slide presentation that accompanies our prepared remarks, which can be accessed on the Investor Relations site, a section of our website at www.netscout.com. You can advance the slides in the webcast, if you were 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 our financial results, and review our fiscal year 2018 guidance.

Moving on to Slide #3, I would like to remind everybody listening that forward-looking statements as part of this communication are made pursuant to the safe harbor provision of the 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 2018 and beyond -- 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 factor.

This slide details these factors, and I strongly encourage you to review each and every single one of them. For 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 #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 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 as a substitute for the equivalent GAAP metrics. Non-GAAP items are described and reconciled in GAAP results in today's press release, and they're 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 the fiscal year 2016.

To provide an apples-to-apples comparison between these 2 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. Reconciliation between the GAAP and non-GAAP pro forma financials are provided in the presentations 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 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 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%, and the operating profit margin of 23% and diluted EPS of $1.92 per share.

Jim will review our performance in more detail, but I will 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 harbor security product area was offset 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 are encouraged that NetScout services assurance revenue grew by double digits.

In the 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 line and rising from the product rationalization and the ramping of new manufacturing at distribution channels. We've 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 search and capacity expansion initiatives and new customer wins following highly publicized advanced denial of service adaptive and in spite, in the 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 improvements. We've continued to solidify our market and technology leadership in both verticals. We've fully integrated the key assets we acquired from Danaher and we've 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 #7 to cover this progress. This slide helps illustrate our progress since acquiring the Danaher Communications business nearly 2 years ago, and framed it against our outlook for fiscal year 2018.

Over the past 2 years, we 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 with 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 light in OTT traffic from 4G subscribers that's training the infrastructure and associated CapEx. At the same time, revenue growth is grooming elusive for mobile operators, partly due to competitive all-you-can-eat calling the data plans and that's forcing them to limit their capital spending. This has created a headwind 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 price software solution for services for the huge cases, without compromising the associated value is becoming increasingly appealing to major service providers. We recognize this opportunity some time ago and we have been evolving our solution for service providers with a software strategy that can help these customers maximize the utilization of the service assurance budget while also enabling us to solidify our incumbency, gain, major top line certainty, while multi-year deals and with new business in a price sensitive market while substantially increasing our gross margins.

Our new InfiniStreamNG, for next generation platform is now available in software forms and combines the best features from the legacy NetScout and former TekComm 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 5-year, $75 million deal with a U.S. Tier 1 carrier, who is using NetScout technology to consolidate the service assurance vendors and gain more pervasive visibility.

Yesterday, we announced another significant multiyear agreement with Vodafone -- with the Vodafone group in Europe. Under this multiyear 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 core 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've 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 will be many more service providers, who will deploy our software in fiscal year 2018. Based on the deals that we've 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.

Overall, we continue to see attractive opportunities for growth in our enterprise service assurance and cybersecurity product areas, as we expand our breadth and depth of our product portfolio. By executing well on this front, we believe that we can drive high single-digit to low double-digit growth in the enterprise and mitigate and anticipated decline in the service provider vertical, as we accelerate our 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 '19 and beyond, while continuing to enjoy further gross margins and operating margin expansion.

Moving onto Slide 8. NetScout is focused on delivering true business assurance to our global customer base by addressing the service assurance and security assurance requirements. As a reminder, the basis of our technology platform is our patented Adaptive Session Intelligence technology or ASI, that converts network graphic data or wire data or structured matter data or smart data in real time. ASI is enabling us to deliver an exciting range of analytics, spending network application and infrastructure performance management, cybersecurity and business intelligence. As you may recall, the first proof point of our integration efforts 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 cot servers, that the customer procure and in virtualized form to monitor private and public cloud environments, virtualized -- as well as virtualized network functions and traditional IT server farms.

As I've detailed, service providers are increasingly recognizing, their deploying our InfiniStreamNG software can help them instrument deeper into the 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 analytic solutions, for example, will be generally available to service providers later this quarter. In the enterprise, we are advancing 3 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 mitigate -- migrate applications and workloads to private and public clouds, as well as gain increased visibility into traditional physical and virtual server form.

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 application, network devices and servers that have been spending heavily on dedicated third-party IPM tools.

Third, we are also advancing product integration and cross-selling between Arbor and NetScout sales need. Later this summer, we plan to integrate our InfiniStreamNG with Arbor spectrum advanced search analytics, which helps the enterprise security teams to quickly and accurately detect and confirm hidden threats. We also plan to leverage our enterprise service, such as our sales force to market spectrum into our installed enterprise customer base, while also taking advantage of NetScout historically strong federal presence to sell both spectrum and our DDoS solutions to government agencies.

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

More specifically, we anticipate that the accelerating -- that accelerating the transition to our new software platform will help increase gross margins by 1 to 2 percentage points and serves as the primary driver for operating margin growth in fiscal year 2018. While we're excited about the potential of our newest products, we are taking a relatively cautious view on their contributions this year, since many of them have yet to be officially launched and it'll 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 #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 engaged user conference. This year is engaged as record attendance with CIOs, CFOs 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 timetable 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 give you several notable wins. Our carriers 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 with another software-only win in the Asia-Pacific region next year -- next quarter. In the Enterprise, we closed approximately $3 million in orders during the fourth quarter with a global payment technology leader in support of multiple projects. All of these long-standing customers’ orders was for consolidating their service GIS tools by standardizing on our nGeniusONE platform and moving away from a dual sourced vendor strategy that had included riverbeds OPNET products. Another order involved the buildout of 2 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 involving 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. We seamlessly extend our monitoring and diagnostic work flows to applications running 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 this volume synthetic test results derived from the infrastructure itself to our ASI data set.

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. These 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's spectrum analytics with our InfiniStreamNG as the source of packet data. This unique combination can be a tangible difference in finding and isolating advanced threats faster, thereby including the effectiveness of existing security staff by up to 10x. In summary, we are pleased with the way we finished the year -- 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 cycles 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, the will be our focus on our non-GAAP results and comparisons between fiscal years 2017 and 2016, are on a pro forma basis unless otherwise noted.

Slide #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 work 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. Services revenue grew by 2%, while product revenue declined by 1%. Our gross margin improved slightly as favorable shift 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 2 customer verticals, service provider 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 verticals 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 provider. Excluding the service providers revenue from both years, our service assurance portion grew by about 25%. Additionally, within the service provider verticals, 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 nonfederal government and commercial sectors including financials. This growth was partially offset by a decline in federal sector, which is common in an election year.

Our cybersecurity product 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 form of 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-leap time legacy projects within our international service provider verticals along with higher demand from overseas operators due to the combination of 4G becoming more mainstream in certain geographies and the buildout of 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 a 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 stocks this past quarter. For the second consecutive quarter, the strong swift drive 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 2-year anniversary of the Danaher Communications business acquisition approaches, we are working with our board to review our financial policy, 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 of 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 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 it 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 prospect 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 topline declines in the high single-digit percentage range in our service provider verticals 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 over fiscal year, which is consistent with the company's historic performance. While specifically, we have traditionally generated around 45% of total revenue in the first half of 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 will 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 the 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 sale size purchases. This dynamic, combined with a difficult comp at Arbor, will contribute to a tough quarter for service provider. And secondly, although, we are launching many new products within the enterprise vertical, we anticipate that the pipeline 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 current quarter expenses will be down in the mid-single-digit percentage range over the prior period. For other modeling assumption, 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 #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, Leo, you may now begin the Q&A session now.

(Operator Instructions) We'll take our first question from Mark Kelleher of D.A. Davidson.

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 enterprise area. Is there a way you can give us an idea of what percentage 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 is that bottomed out?

I think we did talk about, Mark, that I think it has bottomed out now and I think we're beginning to see an uptick and we don't see any real impact on that -- negative impact on this in the coming years.

We'll take our next question from Alex Kurtz of Pacific Crest.

So the high single-digit decline 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 what -- I guess, what's that percentage of the follow-up? What's that percentage in the service provider segment?

I'll let Jean tell maybe specific percentage. But overall, software strategy is a way 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'll rather do it ourselves proactively. And so that's what is resulting in 10%, the number we forecasting for this year is on low single digits this year. And the next year, we hope that we'll be accelerate that beyond 10% and that will result in even better gross margins. So but for overall the dynamic playing in the sector and the customer has access amount of budget and unless they can buy sufficient capacity for that demand, they rather not do anything or to go to cheaper solutions, less attractive but cheaper solutions. And by we coming up with the software solution and is evidenced by the couple of big deals we announced, this would've been impossible without the software solutions.

Okay. And, Jean, the Arbor growth at 14% in enterprise. Was total Arbor growth approximately that kind of rate? Or it was 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 come 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. In the market, generally, growth anywhere from 12 -- 10% to 12% and although when you normalized 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 it turned to Arbor.

I think I just wanted to point out one interesting -- additional dynamic for all the audience, as it may not be clear. 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 gem for the enterprise. So that makes the -- it's very difficult to take the service provider's number and say how much was real enterprise because if the service provider, includes not only the stuff they're consuming for themselves, but what they're using as it is selling a service and it is hard for us to separate that out. So that's why the service provider number looks higher than that actual.

And I'll just 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.

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.

So I think we were NetScout, was always a software company. We just shift most of the software with bundled hardware. TekComm on the service provider side was primarily a hardware based company -- custom hardware and that affected, obviously the gross margin and the combined margin of the company in the service provider sector after the acquisition, because there was a bigger dominant portion of the revenue. So what we saw last year was that custom -- we have the best solution, and we were the #1 and #2 player and combined we are 50% market share and everyone wants to use our solution. But they were looking for 2 things. They were saying -- 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 #1 initiative for the company, which is why it started almost [18%]. And so that's what we have delivered now. We delivered Phase 1 of that last year, which was a software solution but with only NetScout Technology and we just starting to deliver now the combined solution in the software form. And I think that creating the best of both worlds for the customer or best-of-three world in the sense that, they're getting the best free technology from the 2 companies in a single platform, they're able to have a price point, which fixed 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 and -- but there is an indirect impact on our 4G solution because of the software strategy. So in fact, many people are looking for 5G solutions, they will traditionally look for incumbent who can satisfy what are their needs and most probably budget and the value perspective. So moving to a software model that I think I just described, allows us to be the #1 player in the 5G area, but it is not going to really impact -- have a meaningful impact on the revenue in the coming year.

Our next question comes from Matt Hedberg of RBC Capital Markets.

You guys talked about getting gross margins back to the historic levels of, I think near 80% versus kind of mid-70s 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 because InfiniStreamNG has become the combined platform for TekComm and NetScout moving forward. And So we're leveling the software and appliance version and so margins are already increasing even with the appliance version because it's higher gross margin than the TekComm is custom hardware version. But we think that, this will allow us to reach over 80% gross margin target sooner than we would've thought earlier. And maybe even exceeded 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, cybersecurity product already achieved a margin higher than 80%. You know the legacy NetScout product were probably a little higher than 80% also and then when you move to software-only, that would have a probably a 90% or greater margin. So if you talk about in the past, those products and those are the products that were really driving should help to improve the gross margin. As the some of the legacy products like some of the Fluke product, systems product, some of the software related to tech also it gets integrated to the InfiniStream. The drag on margins from those 2 product areas should dissipate over FY '18 and then further into '19 and '20.

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 brace notification? Or is it hard to sort of quantify the benefit of that?

Yes. Not directly familiar with this. But overall, our -- 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 is -- has bigger budgets allocated on the international side, that's what we've seen in the service assurance side.

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

I just wanted to sharpen my pencil here on the Q1 guide. If we start with $278 million of non-GAAP revenue in Q1 of '17 and we're decrementing that you said high-teens just because of this abnormal skewing here in FY '18. 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, high-teens, I only think high-teens would probably be closer to 18%, 19% rather than more of a mid-teen, 16%.

Okay, so all right. Given that substantial drawdown I'm looking at any PS 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?

No, I think that the 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 renewal/expansion there. You characterized the win as kind of them choosing you because of the ability to standardize and do something repeatable. I think if you go a little deeper there, might help me get an appreciation for some competitive advantages of you versus other providers?

I think when you look at the service assurance, which is the biggest portion of the revenue for the company and even if it is service assurance, service provider is a bigger portion for us. So standardized means, that we are the exclusive provider of service assurance solution and there is no competition, in that -- and we have a -- and the standardization also mean 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's no contract or anything. It's basically just order. We have a price on the product negotiated based on this deal and we just ordered. This is they don't need to go to various places. As long as their 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, it stands as a competitive and as we move to 5G virtualization in other areas.

Hi, Eric, this is Jean. Just to add on, Vodafone is architectural decision that coupled with our functionality and even management. And it is an example of the products suite that we have where we can go in a catering service provider from the ram, which should help us in 5G, all the way to the data center, which where our service assurance product have been heavily invested. And also in analytics and through 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 tools, that's just a lot of our customers trouble with.

(Operator Instructions) We'll take our next question from Kevin Liu of B. Riley & Co.

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 sort of the expectation baked in for the declines over there, over the course of '18?

Hi, Kevin, this is Jean. I'll say that we're -- we've been a long-term customer and we are in negotiation and discussion and relationship management with them. As you would know from reading the headlines a lot of the customers have been hit lately with the all-you-can-eat plan. 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 are 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 values that we've provided to them and continue to place orders with us over the next 3 quarters or so. Actually, just I'll add on one comment. We're also talking to all of the Tier 1 as it comes to our software-only solution. So if there's any -- as Anil talked earlier with the budget 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. That actually ties in 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 compared with what they might have traditionally? Or are these really targeted more so that kind of new potential accounts that 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 products from us 4 years ago at the height of empty spending, the numbers will be significantly larger. But the reality is we didn't have a solution -- software solution, we will not get what we're getting. So I think this is a short-term disruption, I call it short-term pain, long-term gain, and it’s a blessing disguise because ultimately, it will promote one of the best solutions in the industry, which is our, to be more pervasive and the enterprise and service providers. Even the software solution would eventually be used in the enterprise also and this will allow us to deliver more value for adding reasonable price to the customers. So that's how i looked at it. I think there are -- here if you compare apples-to-apples, yes, it significantly lowered price for the same amount of product or same amount of coverage versus 3 years ago, but that is not the right metrics. It is the metrics as what would happen if we didn't have the software solution. And I think situation will be really bad and will be effecting what gross margin, topline and operating margins. Now we're able to improve gross margin, operating margin, keep the revenue line intact and then grow from that base moving forward.

And there are no further questions at this time.

Great. Thank you very much, operator, and thanks to all of our analysts and shareholders and investors for listening into today's call. Hope to see you 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.