Ladies and gentlemen, thank you for standing by and welcome to NetScout's First Quarter of 2018 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.

Great. Thank you, Dave. Good morning, everyone. Welcome to NetScout's First Quarter Fiscal Year 2018 Conference Call for the period ended June 30, 2017. As usual, 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. The slides can be advanced in the webcast viewer to follow along with our commentary. We will call out the slide number we are referencing in our remarks. Today's agenda will be consistent with prior quarters. Our CEO, Anil Singhal, will share his perspective on our results and recent highlights. Our COO, Michael Szabados, will briefly discuss key wins and go-to -market developments. Our CFO, Jean Bua, will then review our first quarter results and our fiscal year 2018 guidance. Moving on to slide number three, 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 the Section 21E of the Securities Exchange Act of 1934, as amended, and other federal securities laws. Investors are cautioned that statements in this 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, anticipated revenue from specific customers and all of the other various product developments, sales and marketing, expense management, 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 factor. This slide details these…

Thank you, Andy. Good morning, everyone, and thank you for joining us. Let's begin on slide 6 with a recap of our non-GAAP results. NetScout's first quarter performance was generally in line with our plans entering the quarter, with revenue coming in at $28, $228.8 million, a gross margin of 75.9% and operating profit margin of 6.3% and diluted EPS of $0.08 per share. Jean will review our performance in more detail, but I'll share a few observations. Total revenue declined by 18%, which was consistent with the guidance we provided last quarter. A significant of the, a significant majority of this decrease versus last year was related to the ongoing moderation in spending by one of our Tier 1 carrier customers. Our gross margin improved by 3 percentage points, primarily due to favorable shifts in product mix as we begin to see the benefit of our product strategy. In terms of profitability, we balanced ongoing expense management with investment in major development and go-to-market activities. Overall, we are very pleased with the progress we made over the past several months, to drive innovation and elevate our value proposition. Since holding our annual sales kick-off and user conference events in early April to start the quarter, we have officially included, introduced a number of exciting new products. Let's move to slide number 7 to cover this progress in more detail. As many of you know, our approach to collecting and analyze network traffic or wire data is differentiated by our patented Adaptive Service Intelligence or ASI technology, which instantly converts high-volume network traffic at the collection point into highly structured, multidimensional metadata or what we call smart data. We are using this smart data to power an expanding range of analytics spanning network performance, application performance, cyber security and Big…

Thank you, Anil and good morning, everyone. Slide number 10 outlines the areas that I will cover. Moving into this fiscal year, that is 2018, one of our top priorities has been to fortify our incumbency with service providers by driving adoption of our software-only platform. We are continuing to make progress on that front. During the past several months, a major mobile operator in the Asia-Pacific region selected and began deploying our InfiniStreamNG software as part of its strategy to improve overall network quality. The former TekComms business was an incumbent at this account but had seen its revenue drop to insignificant levels in recent years after a multi-year period of aggressive investment to support the build-out of the carriers 4G/LTE network. More recently, this carrier saw service outages spike, which resulted in negative press coverage and higher subscriber churn. After conducting an extensive technical review to evaluate the range of solutions, this customer selected the InfiniStreamNG as its new monitoring platform due to its superior next-generation features, combined with the ability to support legacy workflows and the compelling total cost of ownership economics. We expect that this multi-year agreement will generate revenues in excess of $5 million per year. In addition to this deal, this customer recently expanded its relationship with Arbor for a major DDoS mitigation capacity expansion to help protect its network and improve its ability to offer a DDoS managed service to its customers. The frequency, complexity and volume of DDoS attacks continue to rise, continues to rise and our ability to keep pace is critical to both service providers and enterprises placing the continued trust in Arbor. We recently announced plans to quadruple the mitigation capacity of the Arbor Cloud DDoS managed service to 8 terabits per second by the end of the calendar…

Thank you, Michael, and good morning, everyone. This morning, I will review key metrics for the first quarter of fiscal year 2018. After that, I will review the guidance for fiscal year 2018. As a reminder, this review will focus on our non-GAAP results, which are reconciled with our GAAP results in the appendix of the slide presentation. Slide number 12 shows our results for the first quarter of fiscal year 2018. For the quarter, total revenue decreased 18% to $228.8 million. Our gross margin of 75.9% increased by 300 basis points. The improvement in gross margin primarily reflects our progress with product strategy aimed at replacing legacy hardware-dependent offerings with our ASI technology. Our operating expenses were essentially flat, as we continue to control headcount and selectively backfill attrition in certain areas, while we tactically expand our sales force to capture the market opportunities. We reported an operating profit margin of 6.3%. This translated into a diluted earnings per share of $0.08. Turning to Slide 13, I'd like to briefly review the revenue trends for the quarter. As we have discussed on prior calls, we are managing through a significant moderation in purchasing by one of our large Tier 1 service provider customers, as they manage their network evolution. This moderation began in fiscal year 2017, as revenue from this customer declined by well over $100 million. We expect another substantial decline in this customer's purchasing in fiscal year 2018. Our revenue SKU for fiscal year 2018 reflects this purchasing pattern. Turning to the enterprise, this vertical decreased by 9%. The decline reflected the timing of certain large federal deals in the first quarter of last year that did not recur at the same level this past quarter and softness within ancillary product lines. With that said, we are…

[Operator Instructions] We'll take our first question from Mark Kelleher with D.A. Davidson.

Great. Perhaps, you could go into some more insight into the Tier 1 vendor that has kind of moved off on their CapEx spending. Is that expected to continue? Are they, is it a competitive situation? Is there market share lost? Is their move off of spending likely to translate to other carriers? Just some more insight into that Tier 1 carrier would be great.

I think we have talked about it, David, in the past that, about this a Tier 1 carrier and I think this is a development throughout the industry. It just happens to be more concentrated in terms of revenue in 1, so we are, we have the notable impact. But the software strategy was designed partly to impact, to reduce the impact of this kind of situation, which is trailing LTE spend and 4G and otherwise traffic growth with OTT competitive plans, all-you-can-eat competitive plan is putting pressure on carriers to moderate their spending. And that's what is happening, it's not because of competitive situation. In fact, we announced a $75 million deal some time ago with a carrier. We announced Vodafone exclusivity deal. We just announced the Asia-Pacific deal. We had our competitive situation and it actually improved. And that required a lot of investment and integrating the assets from Danaher and Tektronix and then moving to aggressive to do a software plan without necessarily compromising the top line revenue. So while this situation is happening with this provider, we have been able to make up most of it in other places. So just to recap that. Not a competitive situation, it's not a product issue, it's just the timing and what's happening in the industry overall.

And as a follow-up, should we expect that to reaccelerate as 5G comes and the timing of that?

Not because of 5G, but more because of OTT and video surfing. See, 5G is a technology, which is not a complete refresh of the network. It only affects the last mile. So 5G will indirectly impact spending on 4G traffic because the last mile has the potential of increasing the traffic on the network on the core, which will put more pressure on the core, which will need to be expanded and then you'll need more monitoring solutions. But being able to judge big prices, whether you are an infrastructure vendor or monitor -- or a monitoring vendor like us, is not going to be the same as before. So -- but we have been able to manage that by creating a more affordable solution for this increased traffic. So 5G has an indirect impact on spending, but is not directly is the reason for buying more of our solution.

We'll take our next question from Alex Kurtz with KeyBanc Capital Markets. Please go ahead, your line is open.

Yes, just a clarification, then a question. So on this Tier 1 carrier, Anil, is there a sense that there are projects maybe 24 months from now, 18 months from now, that will be software-based that they are starting to initially discuss with you? Or is there just a broad-based holding pattern on any kind of discussion around investments and network performance management incrementally?

I think both depending on the type of project. Obviously, we are -- they are looking at our software solutions. So there is no projects for software. I think software is in deployment mode once the value proposition is established. And the value proposition is based on not only what we have to offer, but what kind of spending appetite they have. So we are in the front of line everywhere, including this carrier, and -- but only when they increase their spending for one reason or another, then we -- our first in line position will deliver our revenue. So we are not counting that to be any 10% customer, but we think we are going to be a make up for this in other areas as we have been doing for the last couple of years and moving forward.

Okay. And Jean, can you just make the case for the set -- there is going to be a lot of questions around this. But just make your case on why the second half is going to play out as you'd expect? I mean, is a lot of this revenue expectation already in backlog, more than historically you would have going in the second half? Just sort of how would you explain it to folks that you're going to see this great ramp into the Q3 and Q4 periods here?

I would say, it's probably 3 things, Alex, off the top of my head. First off, service providers separate from this one particular large Tier 1 client, still tend to buy heavier in the Q3 and Q4 quarters. And so as Anil had explained, we have a lot of strategic partnerships with existing service providers around the globe, and our new product set that allows us to consolidate other vendors and then other tools from vendors and go from the edge of the RAN through the data center up to the cloud, resonates very well with them. That same story and other customers, so in the enterprise with the products that we had talked about earlier related to cloud and APM further go into the APM segment of our addressable market as well as going into IPM, combined with our long-term relationships, resonates very well with them also, as they look to be as efficient as possible in their operating costs and standardize where possible on one particular vendor. And then finally, I think as Michael had said in his comments, in his -- when I talked to the sales force, they're very excited about the opportunities to expand their relationships within the customers and to give new products to their existing installed base. The pipeline that we monitor is probably at the highest it's been in the last 12 months, and has grown in the double-digit range at this point. So at this point, sitting here today, we still feel confident that we will achieve our $1.2 billion revenue, which is our revenue guidance.

We'll take our next question from Chad Bennett with Craig-Hallum. Your line is open. Please go ahead.

Jean, maybe a quick question for you. On your biz development expense that you guys, on a non-GAAP basis, kind of back out of the income there. It was up pretty decently sequentially, I think it was about $5.5 million from roughly $3 million last quarter. I guess I was under the impression that expense would kind of trend down. So can you kind of address that? And then also remind us kind of why we backed this out of non-GAAP and whether or not it's a cash expense?

Sure. The first thing is and thank you for bringing that to the attention on the call. Business development is -- actually has ratcheted down. There is a onetime item in there of about, I'm going to say, about $4 million, which relates to conforming vacation policies across the organization. It is a hit in Q1, but it actually will reverse in Q3. So that's why we took it out of non-GAAP stat. Non-GAAP expenses generally relate to incremental expenses due to the large acquisition and relate to things like professional fees associated with infrastructure projects, facilities those type of things that are not recurring in nature, so distort the run rate of the actual business. However, most of them are cash expenses. So they do flow through our free cash flow.

Got it. And then second question for me, and again, probably focused on Jean. Just in the September quarter guide, I think you talked about, it's obviously a fairly big federal quarter for everybody, you talked about, I think, confidence in the pipeline there. Do you have visibility into the Fed demand for this quarter at this point? Or is that just kind of historical norm kind of September month, kind of fiscal year-end demand that you just expect to happen?

Well, we have -- it's two parts. We already have a group of projects that we know are funded. And so clearly, that goes into our forecast. And then we have a large, very high demand in the federal government for unfunded projects. We look at that on a historical basis and where the projects are and talking to the sales people and estimate how much of the unfunded project demand that we have in the pipeline will come in.

We'll take our next question from Matt Hedberg with RBC Capital Markets.

Jean, maybe to put a finer point on the Tier 1 contributions. Can you help us think through roughly how much maybe your top 2 or 3 Tier 1 customers spent a few years ago versus fiscal '18? Maybe just trying to get a sense for the bottoming effect of that spending cycle?

Sure. So in the, the 2 top Tier 1 customers, when you think about their coverage in the U.S. and their race for subscribers. They probably spent in a year, where they were actually deploying and optimizing their 4G/LTE network, a magnitude of about 10x larger than any of the other Tier 1s. So in FY '14 over FY '15, we saw about a, the similar decline in the other Tier 1, which was about $100 million decline on a year-over-year basis. That particular customer has leveled off. They now spend, I would say, maybe 2x on average what the other Tier 1s or other carriers do around the globe. However, that particular customer, to echo something that Anil had said about the projects that we have and the value that we add, that particular customer has grown anywhere from the mid-to-low double digits over the last couple of quarters. So that type of pattern is what we're seeing with the other large Tier 1. So we expect that similar they will reach a level where they're probably maybe 2x more than other Tier 1 carriers or other international carriers will probably equate to their largest Tier 1 competitor, but we expect that they will still continue to decline this year by about another $100 million. And as Anil had mentioned, we have a long-term relationship with them, we have many projects. It's mostly just focused on their economic condition today and where their network evolution is, and it's not a long result of market share or any kind of competitive issues.

I think maybe just to add to that, just to, because your real again question was about how much of it has bottomed out. So if you look at 3 or 4 top carriers, Tier 1 carriers, 1 of them was NetScout customer and 2 of them were Tektronix. And so the NetScout one bottomed out about 3 years ago. And then we had a big spend we announced earlier, earlier last year about renewing our incumbency and that was a big deal we had announced without the name. The second one had bottomed out last year and that we see a slightly increase in that this year. And third one is in the process of bottoming out this year, which is what Jean is talking about. And so that's basically the situation on the top Tier 1 carriers.

Super helpful, Anil. And then Jean, maybe a quick one, maybe I missed this. But I was wondering if you could help clarify what percentage of product revenue would be software this year?

I believe we said that we anticipate that software revenue as a percentage of product revenue will get close to around 10%.

Okay. So pretty consistent with kind of what you were saying last quarter?

Yes.

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

I want to kind of set the carriers aside for this question. The assumption on the rest of the revenue stream talks about sort of durability of the enterprise, their continued strength and then also on the services side. Could you address the enterprise, should we expect kind of a normal seasonal trend, strong federal in September, strong enterprise through calendar year-end? Is that what the guidance implies? And then also on the services side, one of the things that I get concerned about with the dramatic product decline is that we see a ripple effect in the services in future quarters. What should we be thinking about there?

So I'll take the service revenue, first. I think we believe that service revenue in total on a year-over-year basis should be relatively flat to maybe slightly up at about 1%. And as we've talked about in the past, it's mostly just the -- it's mostly the effect of some large customers. And I'm --when I say that I want to say in the range of 5 to maybe 10 who have large installed base, who negotiate contracts with us on operating expense for this service. It doesn't really affect on margin because if you think about fixed costs contributions in variable, it's still very profitable. On the enterprise, we still feel that we believe given the pipeline that I talked about earlier that we should have a strong federal quarter. Hopefully, most of that is focused in the DoD and some civilian. So we're looking to the government to see their spending and how they will do in the budget. And then we do anticipate that enterprise should continue to be a contributor to revenue and stronger in the third and fourth quarters.

I just wanted to mention, Eric, one -- just couple of other aspects that for a given customer, product revenue is not declining, the ASP is declining with the software. So ASP declining doesn't necessarily mean that total deal size is declining. And because people can use our product on a wider scale for a smaller price because of the software model in service provider, it actually makes our service revenue and that because of our backward compatibility with legacy product much stronger. So yes, you're right that there is an impact on both product and service revenue, but these dynamics are playing which are actually positive.

Understand, thank you. One more question, if I could. On the repurchase program, obviously, you guys were very active in Q1. I was looking at last quarter's press release and it looks like you bought, in all of FY '17, you bought $80 million worth of stock. And then in Q1 here you bought $100 million worth of stock. Would you care to comment on that the trend there?

Sure. We always plan on being active in the market. It's one of our capital structure efficiency goals. And we generally is a 10b5-1 plan and an open-market repurchase. As you know through the RMT rules, that's what we were restricted basically to for that 2-year period. And when we put in the grid, you have to put it in at the beginning of a quarter before the -- before -- when your open window opens. And so in Q3 and Q4 while we intended to be in there, the grid that we set the prices at, at which levels to buy the stock fortunately ran up in Q3 and then it also fortunately ran up in Q4. So it just more exceeded the grids that we had originally thought would be in place for the market price for our shares during that time period. So in Q1 of this year as we continue to deploy our capital, the grid was more in line with where the shares actually performed.

And we'll take our next question from Kevin Liu with B. Riley & Company. Please go ahead. Your line is open.

Good morning. Just a quick follow on to that share repurchase question. I guess, given that most of the $100 million in repurchases were done at a higher average price, are you saying that you're comfortable continuing to buy back at about $100 million per quarter, so long as you have the capacity?

Yes. I -- we constantly look at our operating plans and our strategy and what we think the long-term share price will be, and look at how that is reflected in the current quarter's share price and make a determination on what we think we will be purchasing during that quarter. So we, obviously, were very comfortable with the $100 million last quarter and then we anticipate that we will be active again in the market. And it obviously depends on where the share price goes throughout the rest of this quarter.

Got it. And just switching gears a bit to some of the new product introductions particularly on the cloud management side. Curious for that first deal that you guys closed. What was kind of the sales cycle length that you saw there? And then who are some of the folks that you were competing against in order to secure that deal?

Yes, I would say the sales cycle was about 6 months -- 6 to 8 months and the competition was against one of the most prominent APM vendors in the space and then there was a head-to-head competition for the same kind of deployment in the same servers and same data center environment. So it was a very instructive and rewarding experience.

One thing I want to add, Kevin is that this -- so we were -- this was the existing customer on the network side for us. So one of the -- I mean, the excitement about this was that it's not that we were competing with somebody else. We were actually getting into somebody else's space and creating competition for them and won. So this looks like a good win for us in the application area and which is a good leading indicator of what's going to happen in the cloud. And so we have the only solution in the market, which works on-prem and in cloud and that was one of the reasons. So when they move the applications to cloud, if and when they do that, they don't have to change any of their procedures, processes and use of our tools. And that's going to, I think, resonate. So that's one of the things we are excited about that vSCOUT and vSTREAM is not just cloud product, it allows us to go deeper into the data -- server farms and be a player in a new market, which was not easily accessible to us in the past.

[Operator Instructions] And it appears we have no further questions at this time.

Super. Well, thank you very much, David, for your help today. Thank you to all of our analysts and shareholders -- respective shareholders for tuning in this morning. If you do have questions certainly feel free to get ahold of Investor Relation here at NetScout. And we look forward to seeing you on the road at various investor conferences when that occurs and talking with you about our Q2 results this fall. Thank you very much.

This does conclude today's program, Thank you for your participation and you may disconnect at any time.