Good morning, ladies and gentlemen, and thank you for standing by. Welcome to NETSCOUT's 2nd Quarter Fiscal Year 2018 Results Conference Call. At this time, all parties Andrew Kramer, vice president of investor relations and his colleagues at NETSCOUT are on the line with us today. If you require operator assistance at any time, please press I would now like to turn the call over to Andrew Kramer to begin the company's prepared remarks.
Thank you, Keith, and good morning, everyone. Welcome to NETSCOUT's second quarter fiscal year 2018 conference call for the period ended September 30, 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's a slide presentation that accompanies our remarks and that 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 the slide numbers we are referencing in our remarks. Today's agenda will be consistent with prior call, Anil Singhal, our President and CEO, will review our performance and major highlights. Our COO, Michael Zabados, will briefly discuss key wins, go to market developments. Our CFO, Jean Boa, will then review 2nd quarter results and our fiscal year 2018 guidance. Moving on to Slide number 3, I would like to remind everybody listening that forward looking statements as part of this communication are made pursuant to the Safe Harbor provisions of Section 21E of the Securities Exchange Act of 1934 as amended and other federal securities laws.
Investors are cautioned that the statements in this call, which are not strictly historical statements, including, but not limited to, the statements related to the financial guidance and expectations for NETSCOUT share repurchase activity, market conditions and customer demand anticipated revenue from specific customers and specific products, along with all of the other various product development sales and marketing and expense management and other initiatives planned for fiscal year 2018 and beyond, constitute forward looking statements, which involve risks and uncertainties. Actual results could differ materially from the forward looking statements due to unknown 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, 2017 and the subsequent quarterly report 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 the slide presentation includes both GAAP and non GAAP results, unless otherwise stated, financial information discussed on today's call will be on a non GAAP basis, own link. 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 intended to be referior to or 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 reconciliation supplemental detail are included at the end of the slide presentation, which is available on the website. As we detailed in our press release today, our second quarter results came in ahead of our expectations entering the quarter.
We've continued to innovate and make further progress on our product roadmaps. We move into the second half of the year focused on addressing the challenges that lie ahead in capitalizing on the opportunities we see. With that, the high level background, I'll now turn the call over to Anil. Anil?
Thank you, Andy. Good morning, everyone, and thank you for joining us. Let's begin on Slide 6 with a recap of our non GAAP results. NetScout's 2nd quarter performance exceeded our plans entering the quarter with revenue coming in at $259,900,000, a gross margin of 75.5 percent and operating margin of 16.3 percent and diluted EPS of $0.29 per share. Jean will review our performance in more detail, but I'll share a few observations.
Our quarterly revenue exceeded our plans for the quarter due largely to certain service provider orders that were previously expected for the 3rd quarter, and accelerated into the second quarter. While revenue was higher than we anticipated, it declined by 8% from the same quarter the importer in the prior year, in part due to the ongoing moderation in spending by one of our large tier 1 customers. Our gross margin improved by a full percentage point, primarily as a result of favorable shifts in product mix as we continue to make progress with our software driven product strategy. In terms of our profitability, we have continued to prudently manage our cost even while funding a range of development activities that we believe will play critical role in our long term growth and success. On the new product front, We continue to make important progress with our efforts to innovate and expand our product portfolios and capabilities.
Let's move to Slide 7 to cover that in more detail. As we discuss our approach to collecting and analyze network traffic or wide data is differentiated by our patented adaptive service intelligence or ASI technology. Which instantly converts high volume network traffic at the collection point into highly structured multi dimensional metadata or what we call smart data. We are using this smart data to power an expanding range of analytics that address the growing number of use cases. At the foundation of our smart data strategy is our real time information platform, the ISNG, which offers deployment options that range from traditional appliance to software only.
We introduced this platform last fall, and we are making excellent progress in driving adoption of this flat in the software form factor with our service provider customers. Later on in the call, Michael will highlight how one of our cable MSO customers is deploying our ISNG software to monitor their expensive Wi Fi infrastructure. While the majority of the ISNG deals we are striking are for 1 time perpetual software licenses. A number of international carriers of varying sizes are now advancing discussions for multi year enterprise license agreements. The software only version of our ISNG was approximately 10% of our 2nd quarter product revenue, after the low single digit in the first quarter.
This program reinforces our confidence that this platform will represent 8% to 10 of the total product revenue in fiscal year 2018 and helped drive notable improvement in our gross margin this year. We have executed well on our product roadmaps to augment our new ISNG platform. Last quarter, we unveiled new complementary instrumentation of options and new analytics that extend visibility and enabling deeper, more flexible and comprehensive analysis of both wire and not wide data to support our customer's network performance, application performance, infrastructure performance, cybersecurity and big data requirements. These new offerings are intended to expand our total addressable market and elevate our value proposition as we help our customers monitor virtualized network functions and ensure application performance across both conventional IT data centers and private and public cloud environments identified the root cause of infrastructure issues that band user experience and detect advanced security threats. We have been pleased with the growing interest in these offerings from both existing customers and specs.
During this past quarter, we continued to innovate. In July, we announced the integration between our ISNG and the Arbor Spectrum analytics for network threat analysis, which enables network and security operations team to each benefit from access to network traffic as its data source. Earlier this summer as part of our plan to further differentiate the adverse spectrum, we acquired ePlex system which brings us a small but extremely talented engineering team with deep security and machine learning expertise. Over the coming quarters, We plan to integrate their technology and capabilities into our advanced threat offerings in ways that can support faster more accurate and insightful detection of threat actor behavior. In September, we formally introduced our ingenious business analytics, which exabyte data consumable for big data applications in a scalable cost effective manner.
The product is already being used by more than a dozen service providers to help them automate operations, enhance customer care and deliver personalized services. Similar to how we have coupled our ISNG software from the app appliance itself, we are doing the same for our network packet broker product line. Earlier this month, we announced the availability of the Ingenius Packet Flow X Standard or VFX software for service assurance and cybersecurity monitoring. This aggregation of software driven packet broker functionality from the underlying hardware is unique in the industry, and disrupt how traditional packet broker using proprietary hardware has been priced and licensed. We believe that this will our ability to compete in increasingly price sensitive markets, particularly for small and midsized enterprise accounts.
As a result of our progress in bringing our newest offering and capabilities to the marketplace, we are nearing the end of our latest product cycle. We move into the second half of the year, having made good progress across multiple fronts during the 1st 6 months of fiscal year 2018. This brings us to our outlook, which is covered on Slide number 8. Entering into fiscal year 2018, we set our top line get at around $1,200,000,000 recognizing that keeping revenue relative unchanged against the prior year would be an ambitious goal since our largest Tier 1 service either customers, but continue to significantly moderate their 4G related spending. We continue to expect that this customer's year end year over year decline in spending with us could be up to $100,000,000.
Our plan at the beginning of this year was to offset this through a combination of growth in other tier 1 service provider accounts and by expanding our enterprise business. While our results for data are slightly ahead of our original expectations, we do some challenges ahead in the second half. In particular, that service provider spending environment remains under pressure and this is likely to continue influencing the timing and magnitude of large largest service assurance and security purchases at many of our largest service provider customers. We are also concerned that carrier spending activity in North America could be further compromised by potential M and A activity. In the enterprise customer second, 2nd quarter orders from the government vertical were not strong as we originally anticipated.
And it's unclear which projects have any that went unfunded last quarter, we'll move forward during the second half of this fiscal year. For these reasons, we are taking a more conservative view into the third quarter. Although these dynamic make it more challenging to fill the revenue gap created by the anticipated decline in spending at our largest Tier 1 customer, we have left over non GAAP revenue and EPS guidance for the year unchanged. We continue to focus on mitigating the potential risk that we see through a variety of sales program that are aimed at realizing potential upside opportunities from across our customer base over the next 5 months. As we had demonstrated consistently over the years, delivering on our EPS target continues to be our top priority, And if necessary, we are prepared to take certain actions to adjust our cost structure and preserve our EPS performance to the greatest extent possible.
In closing, we remain confident that our strategic direction and our ability to deliver tangible value to all our customers employees and shareholders over the long term. We are seeing a steady adoption of our new real time information platform across our expensive service provider business. Our newest enterprises, enterprise products are amplifying our value proposition to make us even more strategic value build, interested partner to our customers. Our DDoS solutions remain best in class, and we expanded our security offerings to help customer address advanced security threats. Consistent with this perspective, the board authorized a new 25,000,000 share repurchase program that provide us with the scope to further optimize our capital as we move forward.
We'll give due consideration to the timing magnitude and approach to our buyback activity, particularly as we achieve greater visibility on the issues that could impact our near term results. That concludes my prepared remarks. And I'll now turn the call over to Michael at this point.
Thank you, Leon, and good morning everyone. Slide 10 outlines the areas that I will cover. As we discussed on our prior calls, our top priority in fiscal year 2018 is to 45 our incumbency with service providers by driving adoption of our software only platform. We are continuing to make good progress on this this morning, I'd like to cover a new ISNG software win at a major North American cable MSO. Over the years, this customer has used our traditional solutions to monitor voice applications, programming guide activity across set top boxes and mobile apps, and Wi Fi connectivity.
Wi Fi is a strategic area for this customer, particularly as it seeks to continue promoting this offering to expensive subscriber base as well as market new high quality mobile iconic services for which it can cost effective cost effectively offload mobile traffic to the existing Wi Fi infrastructure. However, tight budgets has limited the customer's Wi Fi monitoring to only its largest markets. Given these dynamics, our ISNG software played perfectly into the customer's plans and is freed up well over $5,000,000 to fund the rollout of our software across the remaining markets over the next couple of quarters. In addition, this customer is also one of dozen dozen plus accounts that has started to deploy our engine use business analytics product. This cable provider plans to use the capabilities these capabilities in conjunction with our ISNG to enhance visibility into its network infrastructure, thereby further enriching the key data sets that should ultimately help it make better business decision and improve the customer experience.
In the enterprise, we are starting to generate additional traction with our new V scout and V stream offerings that we introduced last quarter. These offerings provide enterprises with deeper application visibility, regardless of better dosed apps surrounding traditional data center or in the various forms of the cloud. We believe that these new products will ultimately bring us new areas into new areas of IT organization and enable us to tap into new budgets that were previously quite difficult for us to access. During the second quarter, a large civil service agent is selected and began deploying this viscount in conjunction with NETSCOUT to additional solutions to ensure that key applications operate with peak performance for both internal users and public customers. More specifically, these cards will provide visibility into its critical applications, running in virtual environments on Linux and Windows servers where the agency was previously blind to issues.
This deal, which was valued in the high 6 figures, further illustrates the flexibility of our technology to help our customers and has their ability to deliver high quality applications and quickly identify and triage issues that arise. In security, Arbor enjoyed another strong quarter of enterprise growth. This quarter, Arbor secured a $4,000,000 DDoS order from a blue chip U. S. Financial Services company to refresh and expand its existing deployment of Arbor TMS our in line DDoS attack mitigation solution.
Arbor TMS is the most broadly deployed mitigation solution in the market due to its strength in filtering traffic in real time, thereby allowing business services to remain available, even while DDoS attack is being mitigated Over the past year, Arbor has made significant investments in the TMS platform, increasing its mitigation capacity from 40 gigabits per second to 100 gigabytes per second, while at the same time significantly improving the overall total cost of ownership. The new Arbor TMS solution has allowed this customer to substantially extend its deployment to cover more data centers and on the globe. To further strengthen its reach with smaller and medium sized enterprises, Argo recently announced the suite of new affordable, flexible, advanced DDoS protection options for unified production across hybrid cloud environments. Now a few words about go to market. As we move forward, we are very excited about the potential for our newest products as they move through the initial stages of their respective sales cycles.
In addition to BScout and Bstream, we are also very pleased to see growing interest in our new engine is positive as a highly complementary active testing and infrastructure performance monitoring capability to diagnose infrastructure performance issues impacting servers, routers, load balancers and other infrastructure equipment. We are investing in regeneration activities that will enable us to drive demand and raise greater awareness for the new offerings before existing customers and prospects. For example, as the hybrid cloud continues to grow gain momentum across our customer base, we believe that our participation in events like last quarter VM World and the upcoming AWS re invent conference where yield good results. At the same time, market continues to recognize our product as best in class. For example, during the past 4 weeks, our Arbor cloud service received 3 significant awards for excellence in DDoS Production.
I hope to share news of similar accolades for our newest products to earn on future calls. This concludes my prepared remarks. 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 metrics for the second quarter and key revenue trends through the 1st 6 months of fiscal year 2018. After that, I'll review our fiscal year 2018 guidance. As a reminder, this review will focus on our non GAAP results and all reconciliations with our GAAP results are in the appendix of the slide presentation. Slide number 12 shows our results for the second quarter 1st 6 months of fiscal year 2018.
Focusing on our 2nd quarter results, total revenue decreased by $23,300,000 or 8 percent to $159,900,000. Our overall gross margin points this quarter. This reflected good progress in improving product gross margins, especially in light of a $25,000,000 decline in product revenue. This improvement primarily reflects favorable shifts in product mix due to ongoing progress with our product strategy that is aimed at replacing legacy hardware dependent offerings with our ASI software technology. Our operating expenses were essentially flat and our operating profit margin was 16.3 percent.
This translated into diluted earnings per share of $0.29. Turning to Slide 13, I'd like to review key revenue trends. As we've discussed on prior calls, we are managing through a significant moderation in per by one of our large Tier 1 service provider customers following several years of elevated purchasing. We continue to expect fiscal year 20 18 spending from this customer declined by approximately $25,000,000. Within our service provider segment, overall revenue declined by 10%.
The decline from that large Tier 1 customer was compounded by a mid teens decrease in Arbor service provider business, as it lapped a tough comparable that was boosted by a product transition for one of its offerings, this time last year. These declines were partially offset by 25 Our enterprise vertical declined by roughly 6% in the second quarter. We saw strong revenue growth with Arbor's enterprise DDoS offerings, Revenue from the core NetScout Enterprise offerings declined modestly due to the government vertical not being as robust as we had expected. Additionally, we continue to see service provider vertical and the mix was 52 percent of total revenue coming from service provider and 48% from enterprise. In terms of revenue by geography, which is calculated on a GAAP basis, our first half revenue in the United States declined due to the decrease in revenue from that large Tier 1 carrier, while international revenue was relatively flat.
International represented 39% of total first half revenue versus 35 percent in last year's comparable period. We did not have a 10% revenue customer for either the second quarter or 1st 6 months of fiscal year. Slide 14 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 curities of $313,400,000. During the second quarter, we used $100,000,000 to repurchase our stock.
At the end of second quarter, our revolver had $500,000,000 of available credit under the existing facility which left us with total liquidity of nearly 2018 was $13,900,000 and it was $63,200,000 for the first half of the year. We anticipate that our free cash In terms of our share repurchase activity, we repurchased 3,2255 shares of common stock at an average price on the second quarter's earnings per share, our buyback activity for the 1st 6 months represents an incremental $0.07 increase to our earnings per share outlook for the year. We ended the quarter with approximately 971,000 shares remaining under our existing 20,000,000 share repurchase authorization As detailed in today's press once we complete the existing program. We expect to be active in the market during this quarter. To briefly recap other balance sheet highlights, accounts receivable net were $215,200,000 down from fiscal year 2017 80 days at the same time last year.
Moving to Slide 15 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 This slide details our revenue and earnings per share targets for the year. Earlier on the call, Anil detailed certain risks that we see customers and meet our annual revenue by accelerating and maximizing our fiscal year 2018 guidance unchanged at this time. As Anil noted, we have taken a cautious view into the 3rd quarter and anticipate revenue in the range assumptions based on our outlook are outlined on this slide. Based on the quarterly impact of these assumptions, most notably, relatively flat operating costs and roughly 80 into 3rd quarter diluted earnings per share in the range of $0.60 to $0.66.
That concludes my formal review of our financial results. Before we transition to couple of months. That concludes our prepared remarks this morning. Keith, I mean, I'll begin the Q And A session. You.
We'll take our first question from Eric Martinuzzi with Lake Street Capital. Please go ahead. Your line is
open. Question,
you talked
a little bit about the, the carrier weakness continuing here. So this is just kind of a continuation of a theme, but you did peel it back talk a little bit about both on the assurance and on the security side. I was wondering, are those, are those both under pressure in equal amounts or is is security more of a surprise for you?
I think security is more of a surprise, not a surprise, but, I mean, as a lot of customers are also finding out that slowly discovering that Arbor is really part of NETSCOUT. So there is some deal consolidation discount pressures, renewal pressure. So that's, yeah, that's somewhat different than what we thought earlier. But rest of most of where the pressure is on the service assurance side.
I think just to add to that, Eric, I think the other thing that Arbor would tell you is it's also an absorption of a lot of the equipment, the DDoS protection that they service providers had bought in the last part of our fiscal year after there was that large attack. And so they probably see it as a little bit of a digestion pause.
Understand. You also talked about potential impact of, carrier consolidation. This isn't the first time that NETSCOUT has been impacted by the potential for carrier consolidation. Are you seeing a pattern repeat here? I'm, I'm specifically thinking back to the the AT and T play for T Mobile as far as, how it's impacting pipelines.
Yes, I think there is some uncertainty. I think that was this may be a bigger impact because that was I think that there was a big difference within the size of the two companies. And right now, what's going on, it's isolated to 1 or 2 cases. So I think it's slightly more complex than the AT and T T Mobile situation previously.
And just to further add on to that, both of those customers that are being both of those carriers that are being contemplated in the news today are both customers of NETSCOUT. And on the positive side, their business strategy is to try to gain subscribers in a fight with a subscriber population with the other large tier 1s. And in that effort, as you know, they're cutting prices on their programs, but they're expanding their network and they're focusing on the quality of their network. So both of those customers are NETSCOUT customers. And we've seen, good growth with them over the last couple of years.
They continue to invest. The one thing that we would have to watch is, as a combination, would that distract people from focusing on the network and with the inventory that both of these customers have caused any kind of pause in spending. So there's upside and downside to that combination.
We'll take our next question from Matt Hedberg with RBC Capital Markets.
Hey guys, good morning. Thanks for taking my questions. Anil or maybe Jean, I guess for both of you guys. You mentioned on the prepared remarks that there are some challenges you're seeing. Neil, you said you're taking a little bit more conservative view to Q3.
I'm curious, to offset that, you're talking about some increased sales initiatives, to help, I assume harvest additional revenue from your base. Can you talk about what some of those sales initiatives are of those sales programs?
So I think one of the things, one of the traditional one is discounts, I think, giving them a bigger solution, some assurance on the on that solution is going to be against Span and across the virtual and the physical infrastructure, say traditional sales program, plus there are some incentives for the sales team and in the second half over and beyond, for meeting the quota. So those are, I mean, nothing special, fairly traditional. And, but, somewhat more aggressive than what we had at the beginning of the year.
Yes. And the only thing I would add to that, Matt, is, as you know, we have an excellent DDoS product, in Arbor and they have good traction in the enterprise. And then as you also are familiar with, we have an excellent customer base in the NETSCOUT core enterprise sales force So we're also, focusing efforts on the cross selling and the combination of those 2 strengths to try to accelerate any kind of DDoS or enterprise selling.
Got it. That's helpful.
And then maybe another one for Anil. Again, kind of referencing your prepared remarks, you talked about the software only version of ISNG. I think what you said was 10% of product revenue. That's great to hear. Can you talk about the ACV, the annual contract value of a software only deal for ISNG versus maybe what a hardware software deal, you know, several years ago might look like for a similar type, commitment.
I think the what we are seeing is, so the biggest trend going on in the service provider side is one of the most important places to monitor for quality and business analytics is the link where there is a lot of OTT traffic. And those traffic rates because of all you can eat plan, another thing is doubling every year. So there's no way they could have, monitor that with the with the with the effective cost and thing at the price level before. So overall, I would say the size of the deals is roughly the same, but they're buying a lot more for that. So normally you would have expected growth that if traffic has doubled, then maybe our revenue for that deal would be doubled or at least 1a half.
But because of the budget pressure and other thing, it's not linear to the traffic growth. And so whether we do it with hardware or software combination or a software combination software only right now, deal size right now will be same. It's just a budget and they say, you do it however you want to do it. The advantage of the software model is for us is that we are able to manage this without impacting the margin, in fact, improving the margin. So that's what is the dynamic playing in.
It's not really software, hardware combination. Customers are demanding, they are demanding a lower price. And for a company of a size, the only way we can mitigate that is through a better margin model, which is software versus small competitors who can just throw a discounted at the dip.
Got it. Very helpful. Thanks guys.
Yeah.
We'll take the next question from Zach Cummins with B. Riley And Company.
Hi, good morning. Thanks for taking my questions. So just starting off, you talked a little bit about your release of Ingenious business analytics which is already in use with about a dozen plus of your service provider customers. Can you talk about the potential impact this new solution can have on deal sizes down the road?
So I think, so in terms of, for the next, I would say several quarters, the biggest impact is it makes us more sticky in account. It doesn't necessarily increase the deal size, but it makes us sticky in account and it makes us more competitive in the past. They will buy a separate infinity stream like product from a different vendor for business analytics and thereby is one from us for service assurance. Now that functionality being in the same solution set makes it possible to do the big deals and multi year agreements, we have been doing across the world, especially outside of the U. S.
And so that's what the big role of business analytics. Second part of that is a lot of people, customers have big data lakes And so they want our rich data set feed into the data lake. So one of the roles of the business analytic is to make and work some of those people into our partners. And we might be announcing one of those partnership over the next 3 to 6 months.
All right. Great. That was helpful. And then on the buyback, you've bought back a $1,000,000 in stock over the 1st 2 quarters and then the board recently approved a new 25,000,000 share program. So should we assume this $100,000,000 pace continues going forward?
Or what are some of the factors that could change the pace of the buyback?
So we have bought, for the first half of the year, roughly $200,000,000, $100,000,000 per quarter of our outstanding stock. And I think as we've talked about in the past, what we generally look at is, the actual itself and what we think of the effects on our share price and whether as an investment in that exactly that share price at that time, if we think it's a good return for our dollars. So we continue to do that going forward. We have substantial liquidity. So we do have the availability to do something that would be more of a magnitude if we so chose.
But this quarter, we expect that we will continue with our share repurchase program and will be active in the market.
Okay, great. Thanks for taking my questions.
And we'll go next to Chad Bennett with Craig Hallum. Please go ahead.
Great. Thanks for taking my questions this morning. So I guess just a question on the guide and the maintaining the guide considering, Anil, your commentary and kind of the the caution that you've talked about before and then the Q3 color that you gave, on the call, The fact that Arbor was a little bit weaker. Enterprise was on a pretty good trend of growth year over year. Looks like that reversed.
I guess maybe it's a simple question. Why stick with with the revenue guide considering how back end loaded it now is and the risks that you guys talked about in the call?
So I'll mention maybe a couple of factors. Just to mention at beginning of the year, despite ups and down tough service provider market are, but I think except for this one tier 1, making up for the shortfall in the bulk tier 1, provide things are going quite well. But they are not going well enough to make up for that big number. And that's probably has changed as time is passing by. But, 2nd half, even though it's much more polarized on the bigger portion in the versus the past, There is these are our best quarters because for especially in service provider because there is a budget flush in Q3 And, and then there is a new budgets in Q4.
How much of that helps us close this gap is not clear to us? So we are traditionally at update guidance in January because we have a better view and better visibility into because not if you want to change guidance then we want to also have to change it to something. So right now, it's not very clear how we see a lot of upside, we see a lot of challenges and we need to see how the Q3 phases out and how to forecast and funnel looks for Q4 before making that decision.
Got it. And then second question for me, the Tier 1 customer that you highlight that you believe will be down, I think, 100,000,000 this year. Have they adopted your software only service assurance solution yet?
Not yet, but, basically, one of the things they were waiting for is they want they love the functionality which were delivered. That this was one of the one of the reason it was the biggest customer was they were a customer of both Tektronix and NETSCOUT. And so they want and both the solutions in the past were hardware software combinations. After the acquisition, they're expecting to before they deploy our software only solution to not only have both the features available in software because they like it, but in a single product. And that just happened 6 months ago.
So that's why we think the future sales to even this customer will be in the software form, but that has not happened yet.
Got it. Thank you for taking my questions.
Thank you.
We'll take the next question from Alex Kurtz with KeyBanc Capital Markets. Hey, guys.
I just had some modeling questions here, and then a bigger question for Nil. So Jean, just running through the Q3 numbers, what you've outlined here and looking into the implied Q4 guide, is this, And then your high single digit number for high single digit to low double digit for EPS growth. I mean, what has to happen in OpEx and margins to get you to that outcome when you look from Q3 to Q4?
What has to happen in the operating expenses to get to
Yes. You expect a big decline in OpEx to get there? And what do you think about product and services margins? Because services margin, looked like it dipped this quarter. So how do you see margins ramping and how do you see OpEx ramping from Q3 to Q4?
So I guess I would say at this point, you know, based on where we come in at the, at the implied fourth quarter guide, we are remaining with our 1.2 ish revenue guidance that the margins are are basically improving because you have higher volume, the operating costs will stay relatively flat. We still anticipate that, and as Anil has said earlier, it's 5 months, 6 months that we have left in this quarter and this year to achieve our goals. So we anticipate that the margins will improve through gross margin and that the operating costs would stay relatively flat. Given if there is some kind of a change in the revenue, there is about if you want to use operating costs as a proxy, there's probably about 5% of costs that we could easily identify to moderate any kind of change in revenue.
Okay. Well, we can get into a little bit more offline. And just back to your previous question about why not derisk the March quarter a bit. Relative to your guide. I mean, Anil, you've outlined some challenges with Arbor, which is kind of a new item in my view.
And obviously some challenges with domestic carriers. So why kind of put yourself in a corner here with, the big sequential growth into the March quarter?
Well, like I said, I think we do the best job of, of the manage that many in the risk versus expectations. As we go. And we still have half year to go. And a lot of good things happened. And if you remember, last year also, there was a similar question.
Around this time of about the concern about the second half. And, we managed to pull that up. And right now, I think the gap is bigger. And so we just feel that we want to not just change something. We need to give the reasons and change it to some x to y.
And we are not in a position to have the level of visibility to do that. Don't want to make a second change again. And so all these are giving up to saying, let's do our analysis. We already gave you guidance for, for for Q3 based on discussion. Yes, that puts pressure on Q4, but I think we'll we don't feel that if this is the right time to make the change.
You feel like there's enough service provider backlog or pipeline, that's pretty well, along the process that kind of gives you that confidence to sort of stick with the number for the second half. Is there enough activity in the pipeline to get there? Or at least it sounds like it's progressed enough that you feel that you can have some confidence in hitting the back half numbers?
Yes. Well, I think confidence may be a strong word at the same time not having visibility is another site of wrong, but I think basically if the probability was 0, we would be making the change right now. And I think that that probability is higher than that is lower than what when we started with the year, but it's still good enough to not for us to not make the change right now.
Okay. And just last your product growth most likely will be down year over year in fiscal 2018. Do you think product can grow next year? Anel?
Yeah. I think I think we are I mentioned that there are a lot of, I think this is a tough transition year for us and, service provider environment changed. A lot of pressure on Tier 1 in the U. S, Tier 1 providers in the U. S.
We had integration challenges. We had some issues with this. I think all the side effects are negative effects of that Dana acquisition. Are, I think, reaching their tail end. And so I think and all the positives of the integrated product road map, all the investment we have made, whether in security or service assurance or service provider has it just beginning to start So I think I'm feeling despite what happened this year, regardless of that, it'll be a good next year because we think that we are on to something, grow growth starting next year.
Thanks Alex.
We'll go next to Mark Kelleher with D. A. Davidson. Please go ahead.
Great. Thanks for taking the questions.
Just
wanted to go back to that Tier 1 issue. You talked about the decline there. Is there any risk that that situation develops at another one of your Tier 1 carriers? And do you sense any competitive dynamic change at the tier 1 carriers?
Yes. So good, good question. So first thing is that there is no other customer anywhere close to that site. And that number. One second is, there was another customer like that and that, that tapered off last year and it actually on the rise.
And it's possible that once we hit the bottom here, it might go on the rise larger, one of the big reason being integrated solution and saft software product. Our competitive environment is actually getting better for us. Partly because only reason competition could win against us was price. And software model has given us a leg up on that front also. I mean, everyone, anytime anyone was winning, it will only pick most of the time, the big factor was, the price we have to reach, we are Worldwide.
We have the combination of electronics and NETSCOT. We have the best technology we're in business for 25 years versus many people for 5, 10 years. So price was the big reason. And our ability to discount our solution, was compromised by margin and other issues and which was not a problem for smaller private companies. And going to a software model has increased our ability for both driving bigger deals in terms of stickiness and otherwise.
Plus, we're very competitive. So I think our competitive situation is constantly improving.
Yes. And it appears we have no further questions at this time. I'll return the floor to management for any closing remarks.
Thank you very much Keith. I'd like to thank everybody for listening in this morning. If you do have any follow-up questions, certainly feel free to reach out to Investor Relations. Look forward to seeing those of you out at various conferences and look forward to our next communication with you.
And this will conclude today's program. Thanks for your participation. You may now disconnect. Have a great day.