Ladies and gentlemen,
thank you for standing by and welcome to NETSCOUT's third quarter fiscal year 2018 results conference call. At this time all parties are in a listen only mode until the question and answer portion of the call. As a reminder, this call is being recorded. Andrew Kramer, Vice President of Investor Relations and his colleagues at NETSCOUT are on the line with us today. I would now like to turn the call over to Andrew Du Kramer to begin the company's prepared remarks.
Thank you, Keith, and good morning, everyone. Welcome to NETSCOUT's third quarter fiscal year 2018 conference call for the period ended December 31, 2017. Joining me today are Anil Singhal, NETSCOUT's Co Founder, President and CEO Michael Zabados, 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. Both the slides and the prepared remarks 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 our commentary. We will call out the slide number we are referencing in our remarks. Our agenda today is as follows. Anil Singhal, our President and CEO, who will briefly review our performance and then address certain questions that have arisen since we announced our preliminary third quarter results and revised outlook for fiscal year 2018. Michael Zabadosch will review customer adoption trends and major go to market activities.
Our CFO, Gene Bullock, will then review our third quarter results in detail our updated fiscal year 2018 guidance. Moving on to slide number 3, I would like to remind everybody listening to that forward looking 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 ending in financial guidance for NETSCOUT revenue and growth profit growth prospects for fiscal year 2019, share repurchase activity, including the ASR, market conditions, customer demand, anticipated revenue from specific customers and specific products, along with all of the other various product development, sales and marketing expense management and other initiatives planned for the remainder of this year and to fiscal year 2019 constitute forward looking statements, which involve risks, uncertainties. Actual results could differ materially from the forward looking statements due to known and unknown risks, uncertainties, assumptions and other factors. This slide details these factors, and I strongly encourage you to review each of them.
For a more detailed description of the company's risk factors, please refer to the company's a report on Form annual report on Form 10 K for the fiscal year ended March 31, 2017, and quarterly reports on Form Ten Q, which are on file with the Securities And Exchange Commission. NETSCOUT assumes no obligation to update any forward looking information contained in this communication or with respect to the announcements described herein. Let's turn to slide number 4, which involves non GAAP metrics, While this slide presentation includes both GAAP and non GAAP results, unless otherwise stated, financial information discussed on today's conference call will be on a non GAAP basis only. This slide, which we also encourage you to read, provides information about the use of GAAP and non GAAP measures because non GAAP measures are not in 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 detail are included at the end of the slide presentation, which again is available on our website.
As we disclosed earlier this month, our 3rd quarter results were notably below our expectations entering the quarter. We expect further challenges to negatively impact our performance in the fourth quarter. And as a result, we've updated our full year revenue and EPS targets accordingly. I'll now turn the call over to Andel for his perspective on these and other matters. Anil.
Thank you, Andy. Good morning, everyone, and thank you for joining us. Let's begin on slide 6 with a brief recap of our non GAAP results. Consistent with our January 10th announcement, we reported 3rd quarter revenue of $272,000,000, which was down nearly 13% from last year third quarter and below our plants entering the quarter by $30,000,000 to $50,000,000. I'll cover the shortfall against expectations in a moment.
We also took steps to recalibrate our cost structure through certain one time adjustments to variable incentive compensation Our third quarter diluted EPS of $0.69 per share also benefited from a lower tax rate. We believe that many of the issues that affected third quarter revenues are likely to impact our performance in the fourth quarter. Accordingly, as we announced on January that we have received or lowered our full year revenue, fiscal year 2018 revenue and EPS outlook. We have spent considerable time over the past several weeks trying to help shareholders understand the issues that are impacting our performance. Rather than follow our conventional format of highlighting key accomplishments in the quarter, I would like to focus my commentary on answering the most common inquiries we have received.
The first question asked about the biggest factors impacting NETSCOUT q33 fiscal year 2018 and full year fiscal year 2018 revenue. To answer this, it's important to provide some perspective. As we discussed previously, we entered fiscal year 2018, anticipating that one of the our largest Tier 1 customers would further moderate is spent with us by up to $100,000,000. This customer has adjusted its overall spending after multiple years of elevated spending to build this 4G and LTE footprint. In recent quarters, the customer has the time to absorb excess capacity and otherwise redeploy equipment to mitigate growing OTT traffic volumes and delivered high second half of three major factors: ongoing and significant service provider capital spending pressure, primarily in North America.
Lentany Enterprise Salescycles as a customer grapple with major digital transformation initiatives and related changes to their technology architectures. And funding delays for multiple large federal government Edge projects. More than half of total shortfall is attributable to the service provider customer segment. In the service provider market, about 3 quarters of the outfall is associated with overall lower than expected orders for our service assurance products, primarily from Tier 1 providers in North America. The remainder of the shortfall is associated with the delays and reduced orders for our Bartita's offerings, in part because the top volumes have moderated from prior years and that is enabling those customers to differ spending.
Our enterprise customer segment revenue was also notably below our plans due largely to funding delays for multiple large federal government projects and longer than anticipated sales cycle within our customer enterprise customer base. I'd like to briefly explain each of these factors. Government revenue was lower than expected. At that time, we are disappointed that a significant pipeline of opportunity which he estimated to be $50,000,000 across a variety of federal agencies was unrealized because funding was for this project had yet to be secured due to a variety of reasons, including the reprioritization of funds to aid disaster recovery activities. We moved into the 3rd quarter with limited visibility into which unfunded projects, if any, would move forward during the second half of our fiscal year.
Unfortunately, we did not see any upside from this pipeline in the third quarter and we no longer believe it's realistic to expect any material contribution from this live pipeline going forward. In terms of lengthening enterprise sales cycles, Our enterprise customers' digital transformation initiatives and the related changes to the technology infrastructure has impacted the timing and completion of deals involving both our traditional products and some of the newer solution we have introduced in recent quarters. Our enterprise revenue has also been affected elbit to a lesser extent by softer than expected orders for certain ancillary enterprise offering. For example, The handheld tool product lines associated with the former Brooke Network unit is likely to end this fiscal year at less than 5% of total revenue. This is a non core low margin product area that lacks synergy with our enterprise sales teams since these offerings are sold through 3rd party distributors.
Given this dynamic, we are looking at a range of options to resize our resources in this area, including potentially divesting these assets altogether. Investors have also inquired whether the lower revenue outlook reflects any notable change in the competitive landscape. The short answer to that is no. In the service provider service assurance product area, we have made good progress with the new software only version of infinistream and G real time information platform. We focus initially on driving deployment with international carriers while the revenue base presented limited risk and greater upside.
We have made good progress thus far and this platform represented approximately 7% of year to date product revenue. Actively qualified this new platform, and we anticipate purchasing from them to begin in fiscal year 2019. In terms of network function virtualization related initiatives, service providers are still moving cautiously in terms of commercial traffic and actual spending. Nevertheless, we believe that we are well positioned to help carriers in this area and one of our European customers recently selected a virtualized our virtualized service assurance solutions to support a multiyear transformation of their infrastructure or physical to virtual. We expect a public endorsement of our virtualization technology by this customer over the coming weeks.
In terms of enterprise network and application assurance, we have seen sales cycle lengthen as customer advance a digital information project formation projects and related changes to the IT infrastructure. Whereas prior decisions to deploy our code solution quickly load and upgrade our expansion of the traditional data center infrastructure. Enterprises now have a broader range of infrastructure options that include private and public cloud migration, and that is extending our sales cycles. Fortunately, we have already made the necessary investment to expand our portfolio to support customers regardless of whichever path they take. In security, Arbor continue to win new DDoS deals with both existing and new service providers.
However, spending on Arbor solution by North American service provider has been limited due to the combination of headline granting DDoS attacks in the fall of 2016 have largely dissipated. That has resulted in fewer multimillion dollar enterprise wins and smaller overall deal sizes versus last year. Our initial foray into the advanced threat market has yet to deliver meaningful run revenue, but we have received valuable feedback of early adopter customers and prospects. We expect to introduce a new release of the solution later this spring that is aimed at taking further advantage of NETSCOUT's technology and footprint across our installed customer base. We also took certain one time actions during the third quarter that removed approximately $25,000,000 of costs, primarily through adjusting variable incentive compensation and we expect there to be some modest benefit from this in the fourth quarter.
However, These adjustments are non accruing, so those costs need to be factored into the fiscal year 2019. Accordingly, we are looking at year of action aimed at increasing operational efficiencies by further streamlining roles across multiple function areas. When combined with potentially restructuring the formal fluke handheld tools business, we believe that this can further improve our profit profile without compromising our long term growth prospects. With that said, our R and D and sales and marketing costs also reflect our ongoing commitment to support risk of customer around the globe who are using legacy products from the former Tektronix and Fluke businesses. We plan to continue to prudently managing these resources as we continue efforts to migrate these customers to our next generation products while those legacy products move closer to the end of their respective life cycle.
The last two questions about order delays on views for fiscal year 2019 can be taken that lacks sufficient visibility to assume that they will materialize next year. This includes certain prospective service provider projects the unfunded federal government pipeline and certain other enterprises opportunities associated with Arbor DDoS and advanced threat offerings. Although we continue to advance our planning process for next year, it would be premature for us to offer we have any guidance for fiscal year 2000 right now. Nevertheless, we are making the necessary investment that we believe can support top line growth in fiscal year 2019. Our optimism for top line growth is based on a few factors.
First, we believe that spending from our largest tier 1 service provider customers has reached a bottom that should be a be stable to mildly improved next year 2nd, most of the product integration challenges are behind us 3rd, we expect a better traction from a new product especially those that can be sold into new areas of IT And Security. Additionally, we believe that our ability to deliver software centric solutions will help us further fortify our incumbency with key service providers, move us down market move us down market to support a broader range of enterprise customers and call in May will reflect these dynamics and assumptions. We move forward with high conviction that we are well positioned to capitalize on a range of exciting opportunities to drive future growth. We anticipate that the combination of continued gross margin improvement and efforts to closely monitor and manage our cost infrastructure should produce further operating leverage. Together with a lower tax rate and lower share count, this should translate into very compelling EPS growth next year.
This optimizes is underpinned by our plan to execute an accelerated share repurchase of up to $300,000,000 in with our amended and expanded credit facility. That concludes my prepared remarks. And I'll turn the call over to Michael at this point.
Thank you, Anil, and good morning, everyone. Slide number 9 outlines the areas that I will cover, which I believe help convey the progress we are making new product cycle as well as our efforts to advance our go to market initiatives. As we discussed on prior calls during the past, 2 plus years, we have focused on considerable software resource or considerable software resources and expertise on driving innovation across the product portfolio. We have extended the deployment options of our real time information platform, the Infiniti team and G from a traditional appliance to a software only for commercial of the shelf hardware hardware and to an array of virtual automatives. We have discussed on recent calls that the software only version of ISNG has been well received by major international carriers and we expect a relatively sizable deployment our software only platform in support of a major 4G and multi roll out later this spring.
As only to describe, we are seeing longer sales cycles, as our enterprise customers consider a broader range of options for deploying their existing and new applications. When our enterprise customers elect to upgrade their traditional data is they can extend their deployments with our appliance and software alternatives as they move their workloads to private or public cloud our new B scout and V stream products seamlessly expand their application monitoring coverage into the resulting hybrid cloud. Our customers consider our ability to provide them with continuity or visibility through disruptive architecture changes and workload migrations to be invaluable. As a result, the number of evaluations and proof of concepts for these products has grown steadily since their launch last summer and we are engaging with new buying centers within the IT organization such as with DevOps and cloud architecture teams in addition to working with our traditional user base in identifying new use cases. The enthusiasm and interest we generated at last quarter's AWS re invent shop was further validation that these solutions are highly differentiated and relevant to multiple departments within enterprise IT Organizations as they plan and implement various phases of that data center transformation projects.
We are also expanding our pipeline for our engine use Pulse software offering that is used to diagnose the root cause of issues impacting infrastructure performance and actively test software as a service applications. This capability complements and amplifies the service assurance solution delivered by our core technology and eliminates any need for 3rd party tool in the monitoring and troubleshooting workflows for our customers' mission critical applications. Our software innovation also extends to our packet broker offering. Earlier this year, we decoupled our packet broker software from hardware with our new PFS 5000 model by creating an open compute platform option for network packet broke we have taken a unique disruptive approach that is starting to resonate in the marketplace. Orders for the PFS 5000 are now outpacing those for our traditional hardware based packet brokers and we expect that to further accelerate next month and we introduce support of in light security tools.
To go to market, during the quarter, we consolidated the previously separate NETSCOUT and Arbor team to help us deliver a more unified presence to the marketplace and better align with our strategy to deliver combined service assurance and security solutions based on our smart data platform. We also anticipate higher levels of collaboration and coordination between those sales teams as we move into next year. We expect to roll out the results and further details of this unification along with our success stories with our new software and virtualized portfolio at our annual Engage customer and sales meeting, making it the most exciting and impactful NETSCOUT user for whom yet. That concludes my prepared remarks. And at this point, I will turn the call over to Jim.
Thank you, Michael, and good morning, everyone. This morning, I will will review our third quarter results, key revenue trends through the 1st 9 months and our revised fiscal year 2018 guidance. As a reminder, this review focuses on our non GAAP results unless otherwise stated and all reconciliations with our GAAP results appear in the presentation appendix. Slide number 11 shows our results for the third quarter 1st 9 months of fiscal year 2018 focusing on our 3rd quarter results total revenue decreased by $39,300,000 or 13 percent to $272,000,000. Our overall gross margin changed by approximately 250 basis points to 80.2 percent primarily due to the one time adjustment related to variable incentive compensation.
Our total operating expenses decreased by $23,600,000 from the prior year largely due to the aforementioned changes in variable incentive compensation and lower sales commissions. The operating profit margin tax rate to 25 percent, which contributed to diluted earnings per share of turning to slide 12, I'd like to review key revenue trends through the 1st 9 months. Revenue in our service provider customer segment declined 16% through 1st 3 quarters. The decline reflects 2 primary factors: 1st, as we have discussed on prior calls, one of our large Tier 1 service provider customers has been moderating its purchasing over the past 2 years. 2nd, revenue for Arbor's DDoS solutions decreased by the mid teens.
These dynamics were partially offset by low single digit growth in all other service assurance service provider accounts. As Anil noted earlier, we expect that service provider capital spending pressures will continue to result in softer order volumes for our service assurance and DDoS product in the fourth quarter. Our enterprise vertical declined by approximately 8.5% through the 1st 3 quarters. Enterprise revenue for legacy NetScout offerings declined by mid single digits through the 1st 9 months. This was compounded by weakness across all other product areas.
Most notably, we've continued to see erosion across the former fluke product lines. Following a very soft 3rd quarter, Arbor's enterprise security revenue only grew low single digits through the 1st 9 months. For the 1st 9 months, the mix of revenue was 53 fee, which is calculated on a GAAP basis. Our revenue in the United States declined sharply during the 1st 3 quarters, large due to the decrease in revenue from that large Tier 1 carrier, while international revenue declined by 5%. International customers represented 40% of total revenue through the 1st 9 months of this year versus 38% in last year's comparable period.
We did not have a 10% revenue customer for either the third quarter or 1st 9 months. Slide 13 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 $383,000,000 an increase of $69,600,000 from the end of September. Our free cash flow for the 3rd quarter of fiscal year 2018 was $72,000,000 and it was $135,900,000 for the 1st 3 quarters of the year. Our third quarter free cash flow reflects favorable changes in working capital due to the collection of receivables and the lower sales volume.
We currently anticipate that As detailed earlier this month and again in today's press release, we are planning to execute an accelerated share repurchase of $300,000,000 later this week. As illustration, using yesterday's closing stock price of $26.10 per share, the ASR would enable to repurchase approximately behalf between 2 to 3 quarters to execute the buyback. The accounting treatment allows us to reduce our share count by approximately 8,000,000 shares or approximately 70% of the ASR immediately upon entering into the agreement. Once the repurchase is technically completed, The share count would be further reduced by the number of shares actually repurchased excluding the number of shares reflected in the initial reduction. Although there will be minimal benefit our diluted earnings per share in fiscal year 2018 it will enable us to significantly reduce the number of shares outstanding next year.
For the third quarter, we did not repurchase any shares. We plan to fund the ASR primarily through additional debt of $300,000,000 We anticipate that our net credit agreement earlier this month that upsized our existing credit facility. The agreement provides for a 5 year $1,000,000,000 senior secured revolving credit facility which is 25% larger than the original agreement, and it has better pricing and more favorable terms and conditions compared with the original agreement. To briefly recap other balance sheet highlights, accounts receivable net were $249,900,000, down from the end of last year DSOs were 82 days versus 83 days at the same time last year and 80 days the end of fiscal year 2017. Moving to slide 14 for guidance, I will focus on the non GAAP guidance and remind you that the reconciliation of our GAAP guidance to our non GAAP guidance is in the appendix.
Anill spend considerable time detailing the drivers associated with lowering our revenue outlook for fiscal year 2018 from the original target of approximately $1,200,000,000 to between $1,000,000,000 $1,025,000,000. In our service provider customer segment, we now anticipate a full year revenue decline in the range of 22% to 25% from fiscal year 2017 levels due to continued capital spending pressure from tier 1 carriers primarily in North America. This is impacting the timing and magnitude of order levels for the company's service assurance solutions and to a lesser extent, capacity related order for Arbor's DDoS offerings. In the enterprise, we anticipate that fiscal year 2018 revenue will decrease between 5% to 7% from fiscal year 2017 levels primarily due to weaker than expected federal spending longer than anticipated sales cycles and softer than expected orders for certain other enterprise offerings. Given our revised outlook for the full year we anticipate 4th quarter revenue in the range of roughly 240,000,000 to $265,000,000.
The wider revenue range for the fourth quarter reflects some uncertainty about the timing of certain orders across both customer segments. We currently anticipate that gross margin should increase to around 77% for this year, which implies that 4th quarter gross margins are likely to decline modestly from quarter levels. This is primarily due to the one time variable incentive compensation adjustment from the 3rd quarter as well as lower sales volume. We anticipate 4th quarter operating expenses that will increase modestly from the 3rd quarter levels by about $13,000,000 to $15,000,000 again due to the 3rd quarter's adjustment related to variable compensation. Other full year modeling assumptions include changes to the tax rate interest expense and the diluted share count, each of which are outlined on this slide.
Based on the quarterly impact of these assumptions, this would translate into 4th quarter diluted earnings per share in the Before we transition to Q And A, I will note that we plan to participate at the Morgan Stanley Investor Conference in San Francisco at the end of February. And we plan to augment that with meetings and other major money centers over the coming weeks. I'll now turn the call back to Andrew Kramer before we start Q And A.
Thanks Jean. As we've outlined, we're moving forward focused on the opportunities that we believe can lead to improved performance in fiscal year 2019, through both top line growth and actions to adjust our cost structure. We will plan to share more details about the coming fiscal year in early May when we report our fourth quarter full year fiscal year 2018 results. Keith, let's begin the Q and A session at this point.
We'll take our first question from Chad Bennett with Craig Hallum. Please go ahead. Your line is open.
Great. Thanks for taking my questions. So, Vaneel, I guess it sounds like on the service provider side, you guys definitely have a I mean, you've always had a very good software only solution. I think the market is probably moved at least on the service provider side, maybe quicker than maybe you guys anticipated or maybe even us. I guess if we look out over the next couple of years and I know it's not easy from a visibility standpoint, when you look at the Tier 1s in North America, I mean, do you have an idea of kind of mix of how much of network monitoring goes to software only solutions versus a traditional appliances over the next couple of years.
Do you can you take a stab at that?
Yes, I think virtually, I mean, the speed of which this will may vary from provider to provider, but we think virtually all So all the sales into all service providers, including U. S. Service provider within the 10 years, within the next 2 years, we'll move the software.
Okay. And I know that the logic or theory previously was when the carrier is deploying software only probes, they can put it in more of the network than they could appliances previously. And that net net from a spend standpoint, there shouldn't be that much of a change to you guys or to the software provider? I guess
That's true. That's true. And but I just want to mention that that was not true in the last 2 years because the spend has moderated to a level where that's going to be true now.
That's going to. Okay. Got it. And then maybe last one for me and then I'll hop off. How aggressively are you seeing the enterprise customers that you deal with move to software only solution.
I don't think you cited it as kind of an issue on the enterprise side, but are you seeing traction there? Then I'll jump off. Thanks.
So right now, the people have not shown a lot of interest on the enterprise side to move to software. But, just to summarize for everyone that we have 3 kinds of solutions. 1 is appliance which you mentioned, which was most of our business or all of our business in the past, then software version of clients, which is what service providers are using, And that one enterprises have not shown a lot of interest, but the 3rd area, which was always software, but nobody was buying. Which is the NFVN virtualization and server function virtualization. So there we are seeing some traction on both sides.
And so we see most of the software on enterprise moving to virtual rather than to carts.
We'll take our next question from James Fish with Piper Jaffray. Please go ahead.
Hey guys, thanks for the questions. I guess we'll start on sort of gross margins. They were impressive at 80% and I know, Jean, you alluded to that this was a lot of one time in nature. Is there anything that makes you confident over the next 12 to 24 months that we could actually continue to hit that 80% range. Whether it's mix of Arbor Networks or just better execution and less of the Fluke Networks just curious as to the sustainability of this 80% level?
So the Arbor network is already in that range. And it had a net card originally 3 years ago was also in that range, but then our mix change with a fluke network and Tektronix, but most of them either have bought them out or moving to software. So, yeah, there is a good chance of getting to that level in the next couple of years.
Okay. And then probably I know, Neil, you talked about this little bit on the call here, but one of the biggest questions that I've gotten is sort of what makes these changes by the large tier one carriers, not sort of the canary in the coal mine for the rest of the service providers. I mean, what gives you confidence that this is essentially the bottom for service provider being kind of down double digits?
So I think first thing is we did hit the bottom in other area, other than Tier 1 provider, we are on the upswing, in generally in international as I talked about our business and margins have increased in many of the areas when you talk about, I mean, 7 or 8 top Tier one providers in, outside of U. S. In U S, we were, it was low adoption and there were a lot of other dynamic, which did us from doing that. And, don't forget that they have a very big installed base and there is a renewal stream of revenue also. And, and so that installed capacity requires upgrades, software upgrades, and they have to buy it in whole.
So because of all those reasons, we think that we have reached a level this year in Tier 1 provider that we should go up despite their move to software over the next 2 years.
All right.
And just to add to that, Jim, since I knew I knew you knew it was a story. The top 2 North American service providers had spent disproportionately larger on their 4G networks than either the other 2 top 2 U. S. Providers. So that spend has moderated by $200,000,000 each over the last few years.
So their range is more in line with the next 2 tier 1 US service providers, but it's still probably a little elevated from that.
So
it's really a story over the last few years of the moderation spend on 4G.
Yeah, no, no, understood that and not to beat a dead horse here, but It seems as though if that's sort of moderating, that we should be talking about decent growth for next year, but at the same time, it sounds as if some of the weakness this quarter was the other service providers not spending as much? I mean, that's more or less the sense that we're getting here.
Yes, the service provider more was some of it was the timing issue, but the big effect was what Jean was talking about, and we feel that we have gotten them to a level where I think we have largely hit the bottom there in the short term because they will buy more software. It will not grow, but couple of years, we should start seeing moderate growth in those areas.
Got it. Thanks guys.
We'll take the next question from Mark Kelleher with VA Davidson. Please go ahead.
Great. Thanks for taking the questions. Maybe just a follow-up on the 4G. What are your expectations for 5G? Do you expect another surge?
And are we still a year and a half, 2 years away from what's the expectation there?
So when we went from 3G to 4G, there was a complete upgrade of the network. Whereas 5G is more, I would say, to lack of better word, maybe last mile. So it does increase the traffic on the core. But it's not a wholesale upgrade of the infrastructure. So there is there won't be the surge will not be anywhere close to what we saw in 3G to 4G, it will be a very small fraction of that.
But yes, there'll be some traffic requirement, but it will not, I mean, traffic increase will cause, more capacity requirement or more capacity from a solution and more, units of, of monitoring, but it'll be largely as a result of traffic growth rather than a network upgrade.
Okay. And just as a follow-up, could you just give a little more detail on your commentary on divestitures? I know mentioned something about divesting some product lines. Can you talk about that?
Yes. So we have a, I mean, Affinett Tools business, which is basically handheld tools, which was which we have been trying various things for the last couple of years. And we came to coming to the conclusion that is not very synergistic with the way we sell other product lines. And that's the area. It's less than 55% of our business right now.
Okay, great. Thanks.
Our next question is from Matt Hedberg with RBC Capital Markets.
In terms of lengthening enterprise sales cycles, it
sounded like part of this
is due to customers thinking through their cloud and digital footprint. I think last quarter, Anil, you talked about putting some additional sales incentives in place. I guess I'm curious going into Q4, what else can you guys do specifically to help
shorten those sales cycles?
I think so I don't know whether incentive is that Liam, we are doing incentive for other reasons, but I mean, cloud migration activities will follow, at their own pace. And it's not really necessarily cloud migration because customers have multiple choices in upgrading their infrastructure. Whenever you have more choices, it slows down the infrastructure upgrade process, which slows down our sales cycle. So I don't think incentive can do that, but we have some new things coming up in our story about how we can accelerate their migration activities through our visibility provided by our product. And I think that could actually shorten the sales cycle.
And so we have been testing that story and positioning and some features with our large customer. And I think we think that and there'll be a big hit when we have the user group meeting in May.
That's great. And then Jean, I guess under the new tax code, can you help us with potential benefit that you'll see to your GAAP or non GAAP tax rates
in fiscal 'nineteen?
In fiscal 'nineteen, so effective tax rate for this year had 1 quarter of the lower corporate income tax at 21% that's why you have the blended 28. Right now what we would probably see is that 28 would go down by a few more points next year. But that is very provisional given the fact that there's still pieces within the legislation that is still being worked out. So on FY 'nineteen, you know, we've mostly benefited from the tax rate going forward. And then on FY19 as we finish our planning processes, I confirm up whether you know 25%, 26%, 24% is a better rate for for us to use for all fiscal year 'nineteen.
The next question is from Alex Kurtz with KeyBanc Capital Markets.
Thanks guys for taking a couple of questions here. Gene, just to continue on the model. Anil talked about optimism for growth in fiscal 2019. How does that relate to free cash flow margin and EBIT margin?
Well, I would assume, given that our cost structure has always been fairly stable. I would assume that increases in revenue would increase our EBITDA margin cash flow should also continue to be probably above 100%. Right now we in by 'nineteen, we're going to be moving from one of our buildings in Texas into another building, a smaller footprint. And that will have some CapEx that is reimbursed and we're looking at the accounting treatment for that.
But you expect to grow if you grow revenue, is it an operating assumption that you'll be flat EBITDA margins now for fiscal 2019? Is that sort of how you're thinking about it? And if there's growth, that's how you'll expand op margins?
Well, I think as Anil said, we were looking at some of the options in our cost structure. So we could see an impact in operating costs. And then as the product continues to morph towards legacy NETSCOUT and legacy Arbor, gross margins will have a higher overall gross margin. And then usually any flow through in revenue growth, would flow to the bottom line that way.
Okay. Just a couple
of last follow-up questions. The $8,000,000 share reduction, we should pencil that in by september quarter that you will have 8,000,000 fewer shares in the, in the, in the flowed? Or what are your thoughts
No, it's what will happen is on I think on Friday we will start executing and we will settle the accelerated share repurchase with the banks So probably about 70% of the expected shares that we'll take out. So I think in the script, I had used 11.5 1,000,000 shares based on the closing price of the stock yesterday. So 70% of 11.5 is like 8,000,000 shares. That should come out of the, earnings per share calculation on what is in the beginning of February. So it will have the full year effect in FY 2019 and then the remainder will be picked up probably 2 to 3 quarters after that.
Okay. And just last question, you made some mention about the Arbor growth rate being down mid teens. Was that just service provider? And if it wasn't, what was the Arbor growth rate at expectations in total for fiscal 2018?
I think we were we had, I mean, uptake because of some software pricing models and the the DDoS attack going up being very high last year. And so very unusual year, so we didn't have a high expectation of growth this year, but it was down. So that was a somewhat of a disappointment and large it was down, as we mentioned, that the Tier 1 capacity requirements and CapEx spending issues was bleeding into the Arbor DDoS business also.
Yes, just so to summarize the year to date for ABA in the enterprise, they've grown in the low single digits. As Anil said, it is a decline in service provider and ABA attributes it to digestion of, capacity that some of the large tier 1 U. S. Providers bought last year after the DYN attack. Thank
you,
guys.
We'll go next to Eric Martinuzzi with Lake Street Capital Markets.
Hey, my question is for Anil. I wanted to jump in the time machine and go back to October 2014 on the announcement of the NETSCOUT acquiring the Danaher Communications business. So just Strategically, obviously, that transaction was based on some assumptions. I want to use this as kind of a lead into a question on go to market strategy, but what has been the biggest market shift? If you go back to the logic that made so much sense in October 2014 versus where we are now January 2018, what's been the big shift.
So let me, Rick, see how I can maybe, maybe it's a big question. But overall, what had there has been a lot of ups and downs. There have been moved to software model. There has been a lot of new product introduction and there has been things about overlap with the Fluke network and the tools business. And so things have been up and down And I think that's some of it was a surprise, but overall in on balance, it was I think one thing we're balancing something else overall.
I think the biggest surprise at that time was the top tier 2 providers going from and going from 100 or 1,000,000 of dollars in revenue, to coming down to much lower level as Gene mentioned at different times, they had spent over $150,000,000 each or even $200. So that dramatically coming down as a result of their own CapEx spending pressure, OTT traffic driving even more growth which puts even more pressure on them, I think if that factor was not there, there'll still be lots of puts and takes, but outside overall number would be on the growth side, maybe single digit growth. So I think that's the highest level summary that that was a big surprise and unanticipated at that time that all these things will happen over the course of 3 year period. Other cases where these changes are happening, we have been able to mitigate them either through the software model or go to market early changes or substitution of the product. So in fact, we are more competitive right now.
Than we were at that time. Clearly, we were competing with each other at that before that. And so, think that's I don't know whether that covers your broad question.
Well, that's where it leads me to my part 2 of the question, which is that business, that $1,200,000,000 assumption back in October 2014, which closed in July of 2015, was kind of a $1,200,000,000 run rate and you had a picture or an idea of what the market was. Now as we as we're over 3 years removed, from the announcement of the deal and 2.5 years from the closing of the deal, what's the right go to market strategy here. Do you have the right go to market strategy? Do we need to do something material in how we're, obviously, there's a reduced appetite on the part of those 2 large players.
I think we have a good better product line, better vision technology, new go to market strategy, but it has been largely ineffective in the face of these other challenges. Now that challenges have been mitigated in terms of resizing the business, I think we'll start seeing the positive effect of those strategies. I think those as those things internally are seen in the international service providers where we have gotten, I mean, you heard about the Vodafone deal announcement, you heard about a $75,000,000 deal we announced based on software alone, which was bigger than anything which has happened with that 5 years before 5 years, in the past. And so there are several good things going on in the company. On multiple fronts, but they were masked by this effect, which we talked about the Tier 2.1 provider now because of we have resized the business, which also requires us to resize the expectation and some of the cost structure that we talked about, which will share with you people in May, I think we'll have we'll be able to show a lot of that progress, moving forward over the next couple of years.
Okay. I look forward to that update.
And we'll take our final question from Kevin Liu with B. Riley. Please go ahead.
Hi, good morning. Just with respect to your software only strategy. Can you just talk in a little bit more detail? You mentioned that you wanted to go international first. Do you see a lot of opportunity even with your top to North American service provider customers today?
And when would you expect to start to close some software only deals with those folks?
I think there'll be the I think any business we do with them or a large portion of the business we do with this, even this tier to provide us a Tier 1 provider, the top 2, and rest of them also, where we have not used software for one reason or another will be mostly software next year. So in fiscal year 2019, we think bulk of the sales today, we are introduce that they are certifying that one of the beauty of a software solution is feature compatibility with the appliance solution. You can use it in Tektronix mode, you can use it in NetScout mode, you can use it in old mode or combined mode. And that allows the people to to basically say, yes, I can move to software, which affects the top line, but we think that we have bottomed out. And given that, we will see a better margin expansion as a result of any sales to this it will take a couple of years to get back to some growth here, but I think we have gone to a new start here with them, even with the Tier 1 provider in U.
S. And we see we have validation of this trend from international service providers, which was sort of 1 year ahead in terms of a deployment time time horizon.
Got it. And just with respect to the other service provider deals where you kind of set a timing issues, can you talk a little bit about what sort of issues those are? Is it decisions over how to deploy or some other factor that would delay those fields?
Yes. What I meant was that in service provider, the business is lumpy. So, for a couple of service providers, one in big international, one in U. S. There are some things we could get could have gotten in Q4 of this year.
Now we may get in Q1 and that's what I was referring to. There's just a couple of not this is not one of those top 2 or 3 providers we were talking about.
All right.
Thanks for taking the questions.
And it appears we have no further questions. I'll return the floor to Andrew Kramer for closing remarks.
Great. I'd like to thank everybody for joining us this morning. Look forward to seeing folks when we're at those at the investor conference on the West Coast as well as other money centers in the U. S. And Certainly, if you have any questions, feel free to reach out to Investor Relations here at NETSCO.
We look forward to communicating with you on our next quarterly call in early May. Thank you very much.
And this will conclude today's program. Thanks for your participation. You may now disconnect. Have a great day.