Ladies and gentlemen, thank you for standing by and welcome to NetScout's 2nd Quarter Fiscal Year 2019 Results Conference Call. As a reminder, this call is being recorded. Andrew Kramer, Vice President of Investor Relations and his colleagues of 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 very much, Erica, and good morning, everybody. Welcome to NETSCOUT's second quarter fiscal year 2019 conference call for the period ended September 30, 2018. Joining me today are Anil Singhal, NETSCOUT's President and CEO Michael Zabadosch, 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. You can advance the slides in the webcast viewer to follow our commentary.
We will call section of our website at www.netscout.com, including the IR landing page under financial results, the webcast itself, under the Financial Information section of the quarterly on the Quarterly Results page. Our agenda is as follows: Anil Singhal will briefly review our second quarter financial performance, highlight key trends in recent developments and discuss our outlook for fiscal year 2019. Michael Zabados will briefly review recent customer wins that help highlight some of our near and longer term growth drivers, as well as recap go to market highlights. Gene Bull will then review our 2nd quarter results, key first half performance metrics and fiscal year 2019 guidance in detail. Moving on to slide number 3, I'd 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 on this conference call, which are not strictly historical statements, including, but not limited to, the statements related to the fiscal year 2019 financial guidance for NETSCOUT expense management and related cost reduction actions and related benefits, market conditions, technology trends, customers, customer relationships, and customer demand anticipated revenue from specific customers and specific products and all of the other various product development sales and marketing and other operational initiatives planned for fiscal year 2019 constitute forward looking statements, which involve risks and uncertainties. Actual results could differ materially from the forward 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 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, 2018, and subsequent quarterly report on Form 10 Q 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 announcement 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 GAAP and non 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 those and other reconciliations and supplemental details are included in the presentation appendix. Which again is available on our website.
Additionally, given the sale of the HNT Tools business, we may make references to certain pro form a organic non GAAP performance trends that exclude revenue or costs associated with the HNT tools business. As a reminder, we have also provided supplemental data for comparability purposes, comparability purposes related to the reclassification of product and service revenue and the applicable costs for prior periods. That information can be found in the press release in the appendix of the slide presentation and on the Investor Relations website. Overall, we delivered quarterly revenue at the upper end of our plans and our diluted EPS results exceeded our targets for the quarter. We also made important progress to lower costs while funding key initiatives fundamental to expanding our business.
As we move into the second half of the year, We've also updated our guidance to reflect a number of factors. With that as a backdrop, I'll now turn the call over to Anil for his prepared remarks. Anil?
Thank you, Andy. Good morning, everyone, and thank you for joining us. Let's begin on slide number 6 with a brief recap of our 2nd quarter non GAAP results. Our second quarter fiscal year 2019 performance was solid. We delivered 2nd quarter diluted EPS of $0.25 on revenue of $224,000,000.
Our top line performance reflected lower revenue across our service assurance and security product lines within the service provider customer segment and relatively flat revenue in our enterprise customer segment. We also delivered improved gross margins and continue to reduce costs during the second quarter, both of which contributed to the strong diluted EPS performance. Gene will review our 2nd quarter results in more detail in a few moments. During the second quarter, we made important financial operational and strategic progress. We took actions to lower our operating costs by divesting a lower margin non core business restructuring key areas within our organization and continue to manage expenses.
At the same time, we continue to invest in key development projects and go to market initiatives that are aligned to our most promising near and long term growth initiatives. As we look into the second half of the fiscal year, we are seeing many of the headwinds that have affected our top line in recent quarters dissipate and believe that they will be largely behind us as we exit this year. I would like to briefly expand on this. In our service provider services on product area, we are seeing revenue from our 2 largest carrier customers stabilize after substantial declines in recent years. Just as important, We believe our progress to fortify our incumbency at many of us of the other largest mobile operators and cable customers will contribute to improved top line results in the second half of this year and beyond.
In the enterprise, we took an important step to address revenue declines within the former fluke Enterprise Network product lines that we acquired along with other Dana Communication Business assets 3 years ago. In mid- in mid September, we sold the former Fluke handheld network test or HNT tools business. Although the remaining legacy Fluke system product have been have been a modest track on our first half enterprise revenue, we have integrated many of highest value capability from those remaining legacy offerings into our broader, ingenious enterprise portfolio. Moving forward we expect that those initiatives will help fuel growth in our ingenious enterprise offerings and more than offset any ongoing revenue erosion from the remaining legacy Flu product lines. The final headwind affecting our top line is our security product area, which represented more than 20% of last year's total revenue.
Today, these products, large consists of distributed denial of service or DDoS solutions. Our carrier and ISP customer have throttled back their DDoS spending over the past 2 years as they absorb excess capacity following substantial investment arising from high profile data attacks. Tito's revenue is now trending behind our original plan as service provider continue to spend cautiously on capacity. Nevertheless, We anticipate 2nd half DDoS revenue for a service provider will output 1st half levels, which will be consistent with historical trends. As these headwinds dissipate and we strive to resume top line growth, we have also taken actions to lower our operating cost and improve our gross margins, which we believe will help amplify future earning growth.
Let's turn to Slide 7 for some additional color on this. As I alluded to the, at the outset of my remarks, we have taken important steps in recent months to reduce our operating costs in ways that do not impede our ability to grow or support customer or run counter to our corporate values and culture. Earlier this year, we outlined plans to reduce annual run rate operating costs by up to $50,000,000 by adjusting headcount related personal costs aggressively managing discretionary spending and selling certain non core assets. We have made excellent progress in each of these areas and now expect to exceed our initial cost reduction target by removing at least $70,000,000 in operating costs Through the first half of this year, our operating expenses declined by 9% from the same period a year ago. In particular, personal cost decreased by over $10,000,000, largely as a result of lower headcount tied to attrition and the management of new hires.
As noted earlier, in September, we completed the divestiture of HNT Tools Business, which removes approximately $30,000,000 of annual operating cost in conjunction and in conjunction with the sale, approximately 120 employees were transitioned from NetScout to the acquirer of the HNT tool business. During the second quarter, we also initiated restructuring across various areas of the business to realign our resources in waste that are aimed at prioritizing investment in growth oriented initiatives and eliminating redundancy arising from the integration of legacy platforms, products and technologies associated with the Diamond Communications acquisition. In conjunction with these actions, we have combined our previously separate service assurance, security engineering teams, started consolidating certain other facilities and implement a voluntary separation or VSP program and other related measures. These programs are expected to result in a net reduction of approximately 145 employees by the end of this fiscal year. We expect that these action will generate net annual rates savings of $22,000,000 to $24,000,000 of which $9,000,000 to $10,000,000 will be realized in the second half of this earlier.
As we move forward, we believe that we can operate a very scalable infrastructure that will require low incremental increases to our operating costs. In addition to adjusting our operating cost structure, we have also remained focused on improving gross margins over the past 3 years we have reshaped and expanded our product portfolio with a focus on delivering higher margins, software centric solutions that address a broad range of customer use cases. Our progress thus far is most evident in the service provider customer segment with our service assurance solution. Only 3 years ago, carriers deployed our Service Assurance solution as appliances and majority of this product revenue carried gross margin in the mid-sixty percent range. Through the first half of this year, 16 of our 20 largest service providers have already deployed our platform as a software only solution.
Which carries gross margins of over 90%. The software only ISNG platform represents 30% of service assurance service provider product revenue for the first half of the year, up from 16% 1 year ago. As adoption of our software only platform grows, along with other software centric solutions for NFV, Business Intelligence, Application Performance And Security we believe that color on the key drivers for stronger revenue performance, not only in the second half of this fiscal year, but over the longer term as well. In our service provider customer segment, we currently expect 2nd half revenue for this segment will be relatively flat to the slightly higher versus last year. With higher service assurance revenue mostly offset by modestly lower DDoS revenue.
In our service assurance, Product area, we expect solid growth outside of the U. S. As we benefit from new projects with top mobile operators in Eastern Europe and Asia Pacific Pacific to monitor new 4G LTE networks. Michael will highlight one of those wins shortly. In addition, as we mentioned on last quarter's call, We also anticipate meaningful contribution from our calibration offering that are helping large tier 1 operators in North America design their new 5G radio access network infrastructure.
At the same time, however, we believe that the larger Tier 1 service provider will continue to limit near term spending or their existing 4G networks. Longer term, we are very bullish that 5G represents an important catalyst to drive higher spending. We believe that this could benefit us as early as next fiscal year, all the visibility remains limited. In addition to expanding their monitoring capacity in their core networks to handle initial 5g traffic volumes. We anticipate that carriers will ultimately evolve their infrastructure over the next few years with greater emphasis on new edge, new edge computing capabilities and NFI technology.
We are very we are well positioned to help carriers in these areas and expect that 5 gs 5 gs field trials for a monitoring solution will continue to ramp ramp over the coming quarters. In DDoS, we move forward anticipating a more gradual recovery in service provider spending than what we originally expected at the start of the year. Nevertheless, We remain optimistic about our longer term growth prospects as the spending environment continues to improve We plan to capitalize by further enhancing our market leading solutions with new automation capabilities, along with more flexible pricing and deployment options. As we look out into next year, we are focused on delivering new innovation that can help our service provider customers further protect their mobility networks as well as expand the range of DDoS managed services that can be sold to their enterprise customer. Within our enterprise customer segment, We are we have been pleased with the growth of our pipeline in decent quarters and we anticipate modest organic growth during the second half of fiscal year in 2019.
While a majority of our, enterprise revenue is still tied to traditional network performance management and related troubleshooting use cases, we expanded our value proposition to broaden our total addressable market. For example, our Viscount and V stream offering help enterprises extend visibility into application performance across the data center and hybrid cloud infrastructure. Over the past several months, 2 of the world's largest public, public cloud providers, Amazon Web Services, and Microsoft Azure have value evaluated our capability by making our application performance management solution available on their respective marketplaces. In addition, we have worked with Azure on their virtual network tab initiative, which results in an agentless solution that provide mutual customer with visibility into applications and their dependencies in hybrid environment comprising both on prem and Azure cloud infrastructure. Michael will provide some further detail on these developments.
Looking ahead, looking ahead, we also believe that enterprise security has the potential to become a major growth engine, and we are investing accordingly. Last last week, we introduced the Arborite Defense Platform or AAD. This solution not only helps enterprise protect against incoming DDoS attack with proven market leading capability, but also serve as the last line of defense against outbound threats perpetuating malware and other threats. We see attractive opportunities to cross sell AED into our services owner service your enterprise customer base, and we are pleased with our initial progress on this front. In addition to AED, introduced new software feature within our ISNG, now named cyber optimizer.
Enterprises can use this package way to cost effectively collect and filter packet data before forwarding it to other security tools. We're also advancing plans for a security specific version of our ISNG platform and new analytics that leverage our strength in packet forensic and an innovative approach to identify advanced threat through anomalous network behavior. Turn to slide number 9 for additional perspective on the outlook and some final thoughts. We have updated our 2019 revenue guidance to primarily reflect the sale of the AT and T tool business and more modest 2nd half recovery in DDoS service provider revenue than we originally expected. Adjusting our guidance by a total of approximately 47,000,000 to account for those factor results in a new range for annual revenue between $925,000,000 to $960,000,000.
Using the comparable accounting standard basis with the prior year and excluding revenue from the AT and T tool business, the midpoint of our update revenue guidance with equity to relatively flat revenue versus pro form a fiscal year 2018. The SKU of revenue between the and 4th quarter is currently difficult to forecast, primarily as a result of limited visibility into timing of revenue recognition for a small number of 3rd quarter revenue in the range of $230,000,000 to $250,000,000. If you are unable to achieve customer expectance on this project before the end of the calendar year, we would expect 3rd quarter revenue at the low end of this range. And revenue from those projects will likely be recognized in the fourth quarter. In terms of our earning performance, we remain on track to achieve our original non GAAP diluted EPS guidance range and have further defined this target to range from $1.30 to $1.40.
Largely due to the anticipated cost saving associated with our recent restructuring actions. Moving forward, we are focused on achieving our second half goals and demonstrating that we can build the sales momentum necessary to achieve the long term final charge target we outlet this past spring. In closing, we made considerable progress this quarter and implement implemented significant changes across our global organization. I would like to thank my fellow guardians at NETSCOT for their continued support and ongoing focus on moving our business forward. That concludes my commentary, and I'll turn the call over to Michael now.
Thank you, Anil, and good morning, everyone. Slide number is right on all lines. We hear you as I plan to cover. As I highlight that we sent in, will also disclose some comments about related market activities. In the service provider market, we are seeing Tier 1 North American carriers aggressively planned for 5G, while top regional carriers in international markets are investing in the build out of their 4G LTE networks.
We recently received a substantial 7 figure order for our ISNG software platform as part of a multiyear project with 1 of the largest carriers in the Asia Pacific region. This relationship has evolved and expanded over the past several years, is an initial deployment of legacy hardware probes. More recently, as part of its plan to increase the speed of deployment and improve its capital efficiency while keeping pace with robust subscriber growth. The customer began rolling out our ISNG software across its network. This mobile operator is also using our packet flow switch software capabilities to efficiently feed traffic to our ISNG platform, while also benefiting from our engineers business analytics product to gain greater insight into subscriber intelligence, subscriber experience.
This customer success migrating from hardware based probes to a scalable software solution that unlocks the power of our smart data, underscores the reasons why Frost And Sullivan recently recognized NETSCOUT with its visionary innovation leadership award for the global network data on analytics industry. In the enterprise, we are making steady progress with our initiative to provide customers with consistent visibility into their application workloads, build codes across conventional data centers, private clouds and the public cloud. Who is using our smart data solutions, enterprises can deliver consistent and high quality user experience before during and after cloud migration. As Anil noted, we have established relationships to list our application performance management solution on the marketplaces of Amazon Web Services and Microsoft Azure. This sends a powerful message to customers and prospects about the operational readiness, scalability and value of our solution.
Recently, we closed another software deal around the $1,000,000 with a large US enterprise to support their planned migration to AWS. To further expand our new sales pipeline for these offerings, we are planning to participate as a platinum partner at the AWS reinvention toward the end of the month, end of this month. In addition, we are working closely with Azure on the virtual network cloud, BTAP initiative to deliver a comprehensive network and application performance management solution to mutual cost by leveraging the native distributed terminal access point or TAP functionality developed by Azure and combining it with NETSCOUT technology customers get an innovative and agentless solution to streamline the acquisition of Miya Data for effective monitoring and assurance in a hybrid environment. Last month at their Ignite user conference, we were recognized as the NPM APM partner in their retail program. On the security front, on your details, some of the progress we are making on new product roadmaps, which was highlighted by the recent launch of Arbor Edge Defense or AED.
We have already closed our first AED sale with a new e commerce hosting customer in North America. We are accelerating cross selling activity for this platform and for our other security offerings to drive adoption into our service assurance enterprise customer base. A great example of our initial success on this front occurred last quarter with Banco Waterram team, one of Brazil's largest banks. This customer is rolling out Ngeniusone with multiple ISNGs, Ngenius packet flow systems or Ngenius Palls and other portable platforms as well as our DDoS solution to ensure that it's mission critical applications and services are always available to both customers and employees. As we move forward, we are continuing to advance sales campaigns and other go to market that can leverage a wide array of strategic technology relationships.
Our partnership with VMware is a good illustration of this. As you may recall, last quarter, VMware fully certified, the NSX edition of BSCOUT as a VMware ready for networking and security. Since then, we have presented regularly at the regional VMOG user conferences. And participated at VM World in Vegas 2 months ago. We've been pleased with the interest that these activities have generated among our mutual customers and expect similar enthusiasm when And at this point, I will turn the call over to Jean.
Thank you, Michael, and good morning, everyone. This morning, I will review key second quarter and first half fiscal year twenty nineteen metrics, along with our updated guidance. As a reminder, this review focuses on our non GAAP results unless otherwise stated, and all reconciliations within our GAAP results appear in the presentation appendix. In addition, due to the sale of the HNT Tools business in mid September, I will highlight certain revenue trends on a pro form a non GAAP basis, which excludes the HNT tools revenue. Regardless, I'll be sure to note when the comparisons are pro form a versus reported.
Additionally, as a reminder from last quarter, our second quarter results reflect the reclassification of certain subscription oriented security offerings as services rather than products, prior period revenue and related costs for those offerings were reclassified to conform to the current period presentation for comparability purposes. That detail is available in the attached financial tables of our press release in the appendix of our conference call slides and it can also be downloaded from the Investor Relations website. Slide number 13 details our results for the 2nd quarter and first half of fiscal year twenty nineteen. Of $224,000,000, which is at the higher end of our targets declined 14% due to softness across our service provider customer segment while our enterprise customer segment posted flat top line results. Excluding ASC 606 and returning related to the sale of the HNT Tools business, which combined to be a net benefit to revenue of approximately $5,000,000 revenue would have been at around the midpoint of our targets.
Despite the overall decline in revenue, our gross profit margin of 76% increased by 0.5 percentage point. Operating expenses declined by 11% due primarily to lower headcount and related personnel costs. We reported an operating cost margin of 14.7 percent with a diluted EPS of $0.25 after taking into account the positive $0.08 effect associated with the adoption of ASC 606 on quarterly diluted EPS, diluted that we offered last quarter.
I'd like to share a quick update
on our headcount. We ended the 2nd quarter with 2770 employees which is down 3 23 people from the same quarter of the prior year, around 1 third of the change related to transitioning between associated with the Fluke HNT tools divested during September. During the quarter, we also began in renting ABSP and other related measures, which we expect to complete by the end of this fiscal year. We anticipate that these actions will result an additional net reduction of approximately 145 employees and generate $9,000,000 to $10,000,000 in cost saving in the second half of this fiscal year. For fiscal year twenty nineteen, we will incur one time cash charges associated with these programs totaling approximately $18,000,000.
Expenses will be a reduction in the range of $22,000,000 to $24,000,000. Turning to slide number 14, I'd like to review key revenue trends. 2nd quarter revenue in our service provider customer segment declined by approximately 25% with double digit percentage decreases in both the service assurance and VDoS product areas. In the enterprise, 2nd quarter revenue was relatively unchanged, on a pro form a basis, excluding the HNT Tools business, our enterprise service assurance revenue grew mid single digits in the second quarter while security was flat. In terms of 1st half revenue trends, approximately 52% of total revenue was generated from the enterprise customer segment with the remainder from service provider.
In terms of revenue by geography, which is calculated on a GAAP basis, Revenue in customers represented 38 percent of GAAP revenue versus 39% last year. We did not have a 10% revenue customer in either the 2nd quarter the first half of the year. Slide 15 details our balance sheet highlights and free cash flow. We ended the quarter with cash, cash equivalents, short term marketable securities and long term marketable securities of $452,100,000, Free cash flow of $1,500,000 includes some one time nonrecurring items such as transaction costs associated with the HNT tools divestiture, severance payments associated with the 1st phase of our headcount we programs and higher capital expenditures to relocate one of our facilities. We continue to anticipate healthy free cash flow conversions for the full year in excess of 100% of our non GAAP net income, excluding payments associated with our headcount restructuring program.
To briefly recap other balance sheet highlights, accounts receivable net were $184,200,000, down by $29,200,000 from the end of March, DSOs were 73 days versus 78 days at the end of fiscal year 2018 72 days at the same time last year. The customers with or ASR during the second quarter. In total, we repurchased 11,000,006,789 shares of common stock with an average price of $27.11. Let's move to slide 16 for guidance, which we've updated reflect a number of items, including our results to date, the sale of the HNT Tools business, cost reduction actions, and new assumptions regarding some of the revenue risks we see primarily related to a more gradual recovery in DDoS revenue in the service provider segment. I will focus my review on our non GAAP guidance.
As Anil detailed earlier, our updated fiscal year 2019 revenue guidance ranges from $925,000,000 to $960,000,000, which is a reduction of approximately $47,000,000 from our original guidance range. Of this amount, $26,000,000 is due to selling the HNT tools business in mid September and removing the revenue that we had otherwise anticipated from those product lines. The remaining $21,000,000 is primarily tied to lower than anticipated DDoS revenue in the Service Provider segment. We've also updated our key assumptions around our fiscal year 2019 operating model, which are outlined on this slide. We currently anticipate full year gross margins in the 75% to 76% range as the benefits of ongoing adoption of our software solutions are likely to be offset by lower sales volume and product mix shifts including the ramping of new 5G calibration design projects that typically begin with lower gross margins $535,000,000 to $555,000,000.
In the second half of fiscal year twenty nineteen, the sale of the HNT Tools business will remove $15,000,000 to $16,000,000 of operating expenses, while the restructuring actions detailed earlier are expected to remove costs of approximately $9 to $10,000,000. Our other assumptions regarding tax rate, interest expense and average we have refined our fiscal year diluted EPS targets within our original guidance range and now expect diluted EPS between $1.30 and $1.40. In terms of our near term outlook, we'll already review the dynamics that are creating the range for 3rd quarter revenue between 2 $30,000,000 to $250,000,000. We currently anticipate 3rd quarter gross margins to be at least 1 to 1.5 percentage points lower in the second quarter due primarily to the calibration projects associated with the initial phases of our customer's 5G network rollouts. We expect that operating expenses will decline from second quarter fiscal year 2019 levels by $5,000,000 to $8,000,000 due largely to the previously discussed cost reduction actions.
As a result, diluted EPS for the third quarter is expected to range from $0.33 to $0.45. That concludes my formal review of our financial results. Before we transition to Q And A, I will mention that Slide 17 detailed upcoming investor conferences, which we plan to augment with additional NDRs and key money centers in the U. S. I will now turn the
you. We'll take our first question from Chad Bennett with Craig Hallum. Please go ahead. Chad your line is open.
Why don't we go to the next question operator? We'll get back to Chad.
Certainly. We'll go next to Eric Martinuzzi from Lake Street. Please go ahead.
Hey, just had a question regarding the growth opportunity. So I'm referring to slide 8 in the presentation here. And to me, I think the, things get more exciting at NETSCOUT as far as an investment opportunity when the service provider business kind of comes back on track. And the the bullets that you highlight under the growth opportunities there, you know, we're we're talking about salad growth outside the U. S.
There's the 5 g potential and then, you know, kind of DDoS, was, was a little bit disappointing and we remain optimistic. But are there any, you know, are there any green shoots so to speak in that service provider business where these growth opportunities that you're outlining could give us some sense of encouragement because really with the the bring down on the the DDS for the back half of the year, I'm just looking for some encouragement, that that service provider business gets back to growth?
So I think there are a lot of things, I mean, green shoots in terms of potential and excitement about next year. There are a few things, additional things. We talked about 5G. Depends on how much traction is there in 5G. Also, I think finally, virtualization and NFE projects are coming to maturity level in terms of people wanting to spend there are other parts of outside of the US.
We are who are investing in 4 g. We announced one one big opportunity, which we got last quarter. There'll be more things. And then in, in April, when we have our user conference, we we are planning to announce something big in the security space for service provider if you look at the security opportunity, it largely did us today, but and DDoS is partly service provider and partly enterprise. But in the main security advanced threat area, we will be talking about, things both for the enterprise and service provider segment.
We have really not applied security to the mobility part of the network. We have been basically service assurance. So those are some of the things which we didn't talk about today because it's too early to announce but we should be able to share it after the end of this fiscal year.
And just, keeping the focus on service provider, you talked about your 2 large North American Tier 1s being stable. By stable, does that mean the the revenues are flat and are are expected to remain flat, or is there Can you give us any visibility on those those North American keywords?
Yeah. The we are not counting on, I mean, there could be upside, but, yeah, what I what we meant was it's not going to deteriorate further this year or next year. And, margins will possibly improve because of movement to software models.
We'll go next to the line of James Fish from Piper Jaffray. Please go ahead.
Hey, guys. Congrats on the upside this quarter. Just my first question. Competitively, we've been hearing kind of rumblings more from the traditional networking guys adding their software assurance capabilities on to their offerings. Are you guys seeing more pressure from those guys per se and bake off compared to kind of traditional peer group that you guys usually compete against?
Thanks.
Yes. Sorry, go ahead. I didn't want to interrupt. Is that the additional thing on the question? Or that's it?
That's just that's it.
Okay. So I think you're referring to the competition from NEMSA and when I look at the history of NETSCOUT, since I started 30 years ago, every time there is a technology done, better is going from routing to switching in the mid-90s, going to, carrier going to IP in mid-2000s. Later on with security. And now with virtualization and 5G, there is a feeling that standard solution won't survive. And, but customers are looking for, and that gives the impression that what people like Huawei, Ericsson, Cisco's, they're going to provide embedded solution.
And every time this theory has been poor proven wrong, I mean, there's always a competition with them. But this somehow escalates at these points. And people are looking for multi a solution, which is independent of multiple vendors. No carriers goes to a single NAMS, for they don't want to depend. They'll typically will have a multi vendor environment.
And we are the only one who can give you a single pane of glass in that multi vendor environment without any biases and all those. So, yes, competition is there. Every time we go to these new things, it creates some disruption. But in the end, it, it creates more awareness of what we do. And usually, this is doesn't really affect our growth.
In fact, it improves double visibility and potential. Got it. And then maybe just on
the Arbor side, the DDoS business whether you want to hear it from some of the public CDN guys out there or some of the private guys doing wellness seems actually like a very robust market. I guess, why is Arbor not more engaged with kind of the broader market and winning more deals? I get that it's more service provider exposed, but I'm just curious as to why that business is actually in more of a decline on easier comps this year?
Yeah, that's a good question. So, and it's a natural to see that because when you look at the market studies, it looks like that market is growing. I think 2 answer to this is we are more we are we are quite big. We are the number one player from a carrier dots perspective. And so we were the most affected by, we had, if you remember, 2 years ago, we have, like, a outstanding year.
20% year over year growth. That was because of DIN attack and people buying a lot of insurance and capacity. So we are somehow paying the price of this, as a result of that, plus US carriers are tailing spending on all fronts including service assurance, which we discussed earlier. At the same time, we have really not used, invested in enterprise DDoS opportunities and not taking advantage of some of the NETSCOT customers who could, we could cross sell So we have invested that this year was a transition year, and we're going to be announcing our new security strategy, including our DDoS solution, at our user conference in April. And after that, I think we'll be able to mitigate some of the challenges on the service provider in the sense that our, our, negatives are bottoming out similar to service assurance.
And our new strategy will start taking off. And the new strategy will have a different way of competing with CDN based solutions like Akamai. And so I guess that's that's basically the commentary. Yes. We have been down.
There are some good reasons for it, partly because of new investment required on enterprise. And, reduced spending on service provider, which largely affected and that's got more than other people. But I think with our new strategy, we are going to leapfrog the computation and start going again next year.
Got it. Thanks, Neil. Yeah.
Thank you. And we'll go next to the line of Alex Kurtz with KeyBanc Capital.
Good morning, everyone. Anil, just on the 30% comment you made about software in the service provider segment. Is there a way to help investors understand what that number could be in more definitive terms with specific timelines, over the next couple of years. I think It's a very encouraging sign that you're seeing uptake in that adoption, but it's also creating some headwind to revenue that it's hard to calculate every quarter. So two things.
Are you able to say by say fiscal 'twenty one, you think at least half that business or more could be software. Maybe have to come back another time. And then Jean, is there a way to calculate every quarter what the what kind of the revenue impact is as some of these service provider customers transition software versus buying the appliance?
So let me just mention. So Alex, good question. And I think we talked about it in the past also. So Interestingly, that for large service provider deals, we are not seeing a revenue or a erosion because of moving to software model. And so for example, when we have, when we are using the software model, for, large, this big deal, which we announced recently, and almost a $50,000,000 to $100,000,000 deal we had announced in the past, last year, if you remember, Alex, we had our actually actual spend on NetScout increased because of the software, we came to price points, which allowed us to mitigate, the the price per unit.
So overall, I think overall in terms of, percentage of software, yes, in 2 years, getting to 50% and the service provider from current 30% is is very possible. And I think short term effect of, revenue decline because the price per unit go down is actually being made up in many cases or most cases by increasing volume and better competitive situation which is making our technology more pervasive.
Okay. And okay, so I guess no question for Jean. On that point. Just on your 2 big domestic operator customers, I know what would take the change their momentum with you. It sounds like 5G could be the answer but it's not clear that's going to happen next year.
So what are the top 1 or 2 things that would have to happen to get those those 2 accounts back to say maybe 70% of what they used to be?
So I think we obviously people like to hear, we get back to those days. I think our strategy is to not depend on those to do 70%. So so we think that, that was the problem. We should not have a 20% customer. And at that time, we had it.
We are moving in direction where we'll have a much broader customer base we are still going to be the biggest vendor for these 2 providers, even at a 5%. So they're like 5% type customer now. And, I think is it going to go slightly up and down, but we are not counting on when we have provided the growth estimates a plan for next 3 years, whether it's margin or growth rate. None of them is depending on, these 2 providers. And doing a much bigger share of the revenue than they do today.
Thank you. We'll go next to Matthew Hedberg with RBC Capital Markets.
Hi guys, good morning. Thanks for taking my questions. In your in your prepared remarks, you talked about V scout and V stream, aiding your APM business. And I think both of them are available now on AWS and Azure. Can you talk a little bit more about how these products might help the enterprise segment and maybe just a refresher on what you see as the competitive landscape there?
So when we look at that, see, we are positioning our company as a smart data company where we say we will provide visibility no matter where you deploy the application. There are players on the cloud side. There are players start ups on the AWS side. And, there are players on the data center side like we were. And there is competition in all three area, but there is no one company which does a great job on providing single pane of glass across all these areas.
Hybrid cloud environment, public, SDN, SD WAN, or data center. And that's our differentiator. And, in that way, we don't look at the revenue vscout or vscout or vscout as particularly important by itself because we look at we provide a complete picture and kind of customers are deploying applications in various places, and they have a hybrid environment And they need NetScout solution rather than bits and pieces, which they'll have to put together from multiple vendors to do that. So our differentiator is We've got v stream complete the picture. We don't know when the full transition to cloud is going to happen, but with our software model, we have similar in all these areas.
And I think the margin for the revenue contribution from Cloud and vScout and vstream will remain small, for short term, but it helps enable the bigger sale, overall sale. Michael, you had something?
Yes, I wanted to add that a number of our customers, we are seeing a trend that the IT is becoming a broker of multiple different data center services, whether public cloud, private cloud or their own on prem offerings and in this role, we are finding a new use case. We are the key tool to be able to migrate and help their internal customers pick the right choice or move around these different cloud choices or data center choices. So we are becoming enabler for this kind of our new IT behavior.
So I think just to summarize what Michael is saying is that They're having a end to end solution. I mean, it's a big word, buzzword end to end. Everyone talks about it, but end to end solution with a single architecture where you can compare before and after, pick up the right choices. Provide the same visibility, and not just consolidating variant data sources is our differentiator. So We compete with cloud only player by saying we have data center also.
We compete with data center people, deployment, saying we have cloud also. And nobody had the A plus B plus C story like we have.
That's great. That's helpful. And then Jean, your prepared remarks, you talked you noted the difficulty, I think, to forecast the split of revenue between Q3 and Q4, there's some timing assumptions there. But I think per your guidance, Q4 is expected, I think, total revenue about 13% or 14% sequential growth in Q4. That's a little higher than we've seen over the past several years.
I guess, my question is when you think about the second half in general, Can you help us on your visibility of just large deals in general on the product side and sort of the comfort level around those, and then I think federal too, I'm sort of interested in that as a sort of a initiative as well.
Sure. So our guidance as a minimum says between Q3 and Q4 is is a little uncertain mostly because we probably have at least 3, double digit in the millions deals that are we're finishing projects for. They're mostly service, they're all service provider that we're finishing some projects on. And that we just need to get acceptance from the customer. So whether that happens on December 31st, you know, it would be a Q3 revenue.
If it happens on January 1st, it becomes a Q4 revenue. And then just traditionally, we have always a Q3 and Q4 heavier SKU due to calendar year end budgets. And then the new budgets coming in in January plus just the accelerators that our sales team are in to be able to get to certain incentives that are important. Them.
Just to add one thing, so that the $20,000,000 gap is not a visibility gap. It's a Q3 versus Q4. Visibility, not a second half visibility gap. And if it comes to the high end of the range, in Q3, then it won't be 13% to 14% in Q4. It will be much less.
Okay. So you see basically you're saying that there's the visibility, the more of the question is when the deals close between Q3 and Q4, not necessarily if they close in the second half. It sounds like your confidence These will close in the second half or is high?
Yes. So these deals are mostly deals that have already occurred meaning the order's already there, and we've been doing work on them. And so it's just a matter of, you know, under our control, when the projects are completed and implemented. And then under the control of the customer as to, for revenue recognition, when they agree and give us acceptance. And like I said, if they did it on January 1st, it would be a Q4 event.
If they did it on December 31st, it would be a Q3 event.
Got it. Super helpful. Thanks guys.
Thank you.
And we'll go next to Chad Bennett with Craig Hallum Capital Group. Please go ahead.
Hey, good morning. Thanks for taking my questions. I'm hopping between calls. So, hopefully, I'm not redundant. So I think in the prepared remarks, you talked about 30 percent of service provider, I believe product revenue for the first half.
Being software only. Do we have a sense of maybe where we, again, if everything goes to plan where you could end the year as as a mix of service provider product revenue from software only solutions?
I don't know, Dean. I think this is probably in the same range.
Yes, I think we can say right now, yes, for FY19, we're probably I'm just doing a quick thought for a second. We're probably given what I had just talked about with the projects that are completing. 30% is probably a good target for the full year of FY 2019.
And so those the 3 double digit million deals that you just mentioned on the prior question, those are all software only. Is that safe to say?
I would say that 1.
2 out of 3.
Yes, 2, probably 2 out of 3 are mostly software.
Got it. And, is, yeah, are we just on the DDoS kind of expectations for the second half. Do you think I understand kind of the you know, the overbuying phenomena last year and and how you're kind of absorbing that this year. Is there anything else in the overall DDoS market that you believe has changed since last year?
No. That's it. I mean, for us, I think overall market is growing slightly. And, we have been more focused on service provider and we have been the biggest player in service provider. And that's that we are the most impacted And, that combined with the U.
S. Carriers. So we are the business is really impacted in Tier 1 U. S. Carriers or U.
S. Carriers deploying TDoS, which is we sort of were the biggest player in that. And we saw the similar effect 2, 3 years ago in the service assurance area as we talked about earlier. And So I think this is the last year where even though we'll grow in the second half versus the first half, overall, the year will be down. And from next year, I will start from a lower base and start growing again.
Right. And maybe last one for me. How much, I guess, as much as you can tell, well, you probably can tell, how much implied 5 g spend is in your second half guidance. And I assume you believe that will meaningfully change or improve heading into next fiscal year?
Yeah. No. At at at the next fiscal year, it's too early to, sir, tell, but I'll just make a comment about that in a minute, but there's very little in the second half of 5 g, but it's very if you compare to 0 versus last year, then AI is significant. And, but the next year, it's all going to depend on 5g rollout, the speed of 5g rollout. And I mentioned about a single pane of glass comment to in response to a previous question.
Why customer would prefer our cloud solution versus other people because we cover all sides of the house. We provide in the hybrid environment. We are the best solution. Similar to that. We talked about why we are competitive against NAMS is because we provide a true vendor independent solution.
Same story applies to 5G. When you have a call going through 4g, 3g, 5g Networks. You need a single pane of glass to look incumbency in 4 g area because the software and better price point, not just better technology, it puts that in front of the line for 5 g projects. So it will all depend on how fast 5G rolls out, but if 5G is not rolled out fast enough, then SVB will be built on the 4 gs site. And in either case, we should see some growth because of that.
And just to be clear, Chad, the 5G related projects that are part of our thinking for this current fiscal year network infrastructures for 5G. So it's a different capability than the traditional service assurance network monitoring solution that we've, you know, it's been deployed across 3g, 4g, and will eventually be deployed for 5g.
Great. Good color. Thanks for fitting me in.
Sure. Thank you.
And now I'd like to turn it back to Andrew Kramer for closing remarks.
Thanks, Erica. I'd like to thank everybody for tuning in this morning. I know it's a busy day for everybody. Look forward to seeing you out on the is, if we're in a money center of yours, we'll certainly be, be looking forward to seeing you there. And otherwise, we'll talk to you in the new calendar year.
Thank you very much.
We'd like to thank everybody for their participation on today's conference call. Please feel free to disconnect your line at any time and have a great day.