Netscout Systems Inc

NASDAQ:NTCT

Earnings Call Transcript 2018-Q4

[Operator]

Good day, ladies and gentlemen. Thank you for standing by, and welcome to NETSCOUT's Fourth Quarter Fiscal Year 2018 Results Conference Call. [Operator Instructions] As a reminder, this call is being recorded.

Andrew Kramer, Vice President of Investor Relations, and his colleagues at NETSCOUT are on the line with us today. [Operator Instructions] I would now like to turn the call over to Andrew Kramer, to begin the company's prepared remarks.

[Andrew Kramer, executive]

Thank you, Keith. Good morning, everyone. Welcome to NETSCOUT's Fourth Quarter and Year-End Fiscal Year 2018 Conference Call for the period ended March 31, 2018.

Joining me today are Anil Singhal, NETSCOUT's cofounder, President and CEO; Michael Szabados, NETSCOUT's Chief Operating Officer; and Jean Bua, NETSCOUT's Executive Vice President and Chief Financial Officer.

There is a slide presentation that accompanies our prepared remarks. Both the slides and the prepared remarks should be available on the Investor Relations section of our website at www.netscout.com. I've been informed that there is been some difficulty in accessing those materials and we'll make -- try to make sure that those are posted and available to you during the call.

The slides, when they are available, should be and can be advanced in the webcast viewer to follow our commentary. We will try to call out the slide number we're referencing in our remarks. And we'll try to keep in mind that some of you may not have slides available as we're talking.

Our agenda is as follows: Anil Singhal will briefly review our performance and then, address certain questions that we believe are on the minds of investors. Michael Szabados will briefly review customer adoption trends and major go-to-market highlights. Jean Bua, will then review our fourth quarter and full year results and detail our fiscal year 2019 guidance.

Moving on to Slide #3. I would like to remind everybody listening that forward-looking statements as part of this communication are made pursuant to the Safe Harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended, and other federal securities laws.

Investors are cautioned that the 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, market conditions, technology trends, customers and customer demand, anticipated revenue from specific customers and specific products, share repurchase activity and all of the other various product development, sales and marketing expense management and other initiatives planned for fiscal year 2019 constitute forward-looking statements, which involve risks and uncertainties. Actual results could differ materially from the forward-looking statements due to the 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, 2017, and subsequent quarterly reports on Form 10-Q, which are on file with the Securities and Exchange Commission.

NETSCOUT assumes no obligation to update any forward-looking information contained in this communication or with respect to the announcements described herein.

Let's turn to Slide #4, which involves non-GAAP metrics. While this slide presentation includes both GAAP and non-GAAP results, unless otherwise stated, financial information discussed on today's conference call will be 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 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 supplemented detail are included at the end of the presentation, which is available on our website.

We reported diluted EPS that was at the higher end of the updated guidance we provided in January, even though revenue was relatively weak. Despite the year's results, there were some positive developments that lead us to be optimistic about our prospects in fiscal year 2019.

I will now turn the call over to Anil for his perspective on these and other matters. Anil?

[Anil Singhal, executive]

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. We reported fourth quarter revenue of $238.5 million and full year revenue of 999 -- $999.3 million, which approached the low end of our guidance range we provided in January 2018. However, the EPS performance for both the fourth quarter and the full fiscal year were reasonably good and at the higher end of the January guidance due to better-than-expected gross margins and lower operating cost among other items. Jean will review our results in more detail later on this call.

Although we were unable to achieve our original targets in fiscal year 2018, we made important progress with our product strategy. We have radically reshaped and expanded our product portfolio over the past couple of years, since acquiring the Danaher Communication business.

3 years ago, our offering were largely appliances with varying levels of proprietary hardware, with the primary use cases for our solution being network performance and distributed denial of service. Today, our solutions are software-centric, feature-rich and applicable to a much larger total addressable market that's beyond -- expands beyond network performance and DDoS to [ encompass ] application performance, advanced threat and business intelligence.

Due to our substantial investments over the last past couple of years, we've moved forward with optimism that will start capitalizing on the attractive opportunities we see in fiscal year 2019. Although market conditions are still suboptimal and the transition to new accounting rules may dampen reported results in fiscal year '19, we anticipate resuming growth -- revenue growth this year and producing gross margin improvement in the process, as we see greater adoption of our software-based offering.

Related to that, we are also advancing plans that we believe will help us further recalibrate our cost structure in ways that can help us improve our underlying operating profitability without compromising our ability to capitalize on near-term and long-term growth opportunities.

With that as the backdrop, I would like to briefly address what we believe are the most pressing questions we are likely to get from our investors.

Let's move to Slide #7 for that. The first question is are the strongest revenue headwinds behind us? The simple answer is yes. The more severe headwinds were in our service provider customer segment. The acquisition of Danaher Communication business brought us a much broader global service via the footprint, but the revenue was highly consolidated with 2 10% plus customers. Over the last 3 years, these customers have declined to the mid-single digits as a percentage of total revenue, as part of their efforts to reduce capital spending on their 4G network infrastructures. Combined, these 2 customers represent approximately 10% of fiscal year '18 revenue, with over 40% of the revenue coming from a very healthy stream of recurring maintenance and support services.

Looking ahead, we expect that spending from these 2 service provider customers will remain relatively stable in fiscal year 2019, with improving gross margins as they continue transitioning to our software-based platform over the coming quarters. Given the overall traffic growth over the networks and the recurring nature of our service and support revenue, we view any potential downside risk from these customers are relatively minimal and very manageable. Just as important, we have made good progress to fortify our income with the other service provider accounts by offering a unique solution, with appealing price-to-performance characteristics.

Second question is about our service provider customer segments. This is a natural lead into the next question about the outlook for our service provider customer segment. We believe that we can stabilize revenue in this segment during fiscal year 2019 and begin growing as we move into the second half of the year as we further strengthen our competitive position.

In service assurance, overall network traffic is still growing, but carriers continue to carefully manage their spending, which impacted the timing and magnitude of larger products -- larger projects during the fiscal year 2018. Although spending pressures are likely to persist in the near term, we continue to make good progress driving adoption of the software version of our ISNG platform. For example, of our 20 largest service provider customers in fiscal year 2018, more than half are deploying the software-only version on either bare metal or virtual or both. And as I mentioned, we expect other large North American carrier customers to migrate to our software platform during fiscal year 2019.

In addition, we are seeing opportunities to capture greater wallet share with our existing customers who require cost-effective visibility into their user plane traffic. While near-term service provider spending is likely to remain muted, we believe that spending on services general tools like ours will enjoy a reasonable growth over the coming years, with 5G and virtualization now entering the early phases of the lifecycle, with the world's largest and most innovative carriers.

We already won some small but strategically important projects with large North American operators, to help them plan and design their 5G radio access networks. Michael, will cover this in more detail in a moment.

Additionally, we are moving into 5G lab testing and planning to support 5G field trials for our core service assurance solutions, with certain Tier 1 customers over the coming quarters. While we are incrementally more positive about 5G as a meaningful long-term revenue catalyst for us, we don't expect substantial contribution for our 5G-related projects in fiscal year 2019. And it remains hard to forecast when major investment in 5G networks will begin.

Along those lines, the number of deployments, proof of concept and trial of our Network Function Virtualization or NFV and monitoring solution continues to grow. However, we anticipate that spending on these products is likely to remain relatively small this year.

Third question is where and why do we expect to see growth in fiscal year 2019? Regardless of the accounting transition, we would expect to enjoy a much better performance in our enterprise customer segment as our enterprise customer advance their digital information initiatives as well as position to support their transition, consolidate their tool vendors and leverage the network traffic we collect for them for multiple use cases spanning from our stronghold in network performance to application performance and security. We call this approach smart data core and it enables enterprises to deploy our product more progressively and cost effectively by consolidating tools across multiple stakeholders within IT.

Over the past several weeks, I have visited with some of our largest enterprise customers and there is general excitement among those customers about our direction, which we plan to share more broadly during our annual user forum in Dallas in 10 days.

A related question about our enterprise growth prospect is what new enterprise budgets we'll be targeting and -- to sell during fiscal year '19. Our smart data core approach extends our reach beyond network operations as a buying center for our offerings. Last year's introduction of vSCOUT and vSTREAM enables us to extend application visibility much deeper into the application infrastructure, regardless of whether those application servers reside in the traditional data center, private cloud or public cloud environment, thus providing a natural single pane of glass, with before and after views of performance. As a result, these solutions are increasingly relevant to DevOps and cloud upstreams.

We are pleased that the NSX edition of vSCOUT were recently fully certified as VMware ready for networking and security under VMware's NSX partnership program. We believe that our ability to provide this unique level of visibility into the NSX environment offers our major customers tremendous value and will add further momentum to our sales efforts. Later on this call, Michael will highlight a recent win that involved our vSCOUT technology.

In enterprise security, we see several opportunities. Within next couple of months, we plan to introduce a substantially enhanced version of our advanced threat solutions, with a broader and richer set of analytics that is more tightly integrated with our ISNG and ASI technology, so that we can drive cross-selling opportunity into our installed enterprise customer base.

Additionally, we are planning to broaden the range of capability within the Arbor DDoS enterprise portfolio that are intended to further differentiate it as an as-defense platform, while also complementing our advanced threat capabilities. We also plan to introduce new instrumentation that is aimed at cost-effectively collecting and filtering packet data, before forwarding it to other security tools they use. This feature, which we call the nGenius Packet Shaper, will optimize our customer spend, help them consolidate budgets and reduce their total cost of ownership.

The last question is about our cost structure and what are we doing to adjust it in fiscal year 2019. As we move into fiscal year 2019, we recognize that we must take steps to realign our cost structure with the near-term outlook in ways that do not impede our ability to grow and support our customer.

As we look ahead, we are advancing plans for the first half of this year that range from reducing headcount-related personnel cost and aggressively managing discretionary spending to selling certain non-core assets. In combination, we believe that implementing this plan would allow us to reduce annual run rate operating costs by up to $50 million from the last year's level.

Although we do not expect to realize the full amount of this saving in fiscal year '19 due to the timing associated with these initiatives., nevertheless, we believe that these plans will deliver meaningful savings this year to help us absorb higher variable incentive compensation based on achieving certain business results and keep our total operating expenses relatively flat with the year. As a reminder, our fiscal year '18 expense base benefited from the elimination of variable incentive compensation, since we did not achieve our targets.

A key component of accomplishing this will be managing personnel-related cost. Total headcount was down about 3% last year as attrition outpaced our new hires. We anticipate the size of the workforce would decline at a higher rate in fiscal year '99 (sic) [ '19 ], as we prioritize investment in our next-generation products and adjust resource level in support of legacy products.

Augmenting this activity, we recently closed one of our overseas development offices, consolidated our security and service assurance marketing teams, and plan to reduce spending on certain discretionary marketing program for the coming year.

Additionally, we are advancing plan to divest the former Fluke tools product area. As we discussed last quarter, this is a product areas that lack sales and marketing synergy with our broader service assurance offering. This product area represented just over 4% of total revenue last year and approximately 5% of our workforce. We believe that selling these assets would help us improve gross margin slightly and lower operating cost. We'll be in a much better position to assess the overall impact of our cost reduction program when we report our first quarter results.

This brings us to Slide #8 for our outlook. To reiterate my earlier comments, I expect fiscal year 2019 will be an important year of strategic and financial progress for NETSCOUT. Based on the opportunities we see, we expect to resume top line growth through higher product revenue over the coming quarters, which will help improve our underlying profitability.

However, we are taking a very conservative view on the first quarter due in part to the anticipated impact of adopting the new accounting standard in combination with the relatively fluid timing associated with certain projects. Even if our reported top line performance in fiscal year 2019 is somewhat muted by accounting adjustments, we believe there is a good potential to drive solid EPS expansion, along with very healthy free cash flow.

Since the completion of the Danaher Communications business acquisition nearly 3 years ago, we have navigated a much more turbulent market environment than we originally expected to preserve our customer base, enhance our competitive position and completely reinvent ourselves as a software company.

Although our performance is behind our original plan, we believe that the steps we have taken and continue to take to accelerate the shift to software, expand our reach into adjacent markets and manage our cost base will play an important role in helping us achieve some of our original operating targets.

For these reasons, we believe it is time to share a new set of long-term targets. Over the next 4 years, I believe we can grow revenue at a compound annual growth rate in the mid-single-digit range or better. With the transition to increasing software-centric product portfolio well underway, we believe that we can continue increasing gross margin into the low 80% range or better. The combination of the solid revenue growth, better gross margin and limited expense growth should produce meaningful operating leverage to support operating profitability in the low 30% range or better. That type of fundamental performance, along with the current tax rate and share count, would result in a diluted EPS CAGR, compound annual growth rate, of greater than 20% to more than $3 per share, along with the annual free cash flow in excess of $300 million.

In closing, I would like to publicly welcome 2 new directors who have joined our work. Al Grasso and Susan Spradley are both accomplished executives with their very relevant experience and we look forward to benefiting from their advice and counsel. I would also like to extend our gratitude to our shareholders for their support during the past year.

Finally, I want to commend our employees for their resilience, tenacity and hard work, which underpins our commitment to our industry to serve as Guardians of the Connected World.

That concludes my prepared remarks. And I will turn the call over to Michael at this point.

[Michael Szabados, executive]

Thank you, Anil, and good morning, everyone.

Slide #10 outlines my plan to cover recent wins and a quick preview of our upcoming user conference. As Anil mentioned, in the service provider market, many major carriers are starting to invest in new 5G network architectures. One early indicator of the potential upside of the 5G spending is our radio access network calibration services, which are used to predict signal coverage, interference and network performance, and thereby, improve capital and operational efficiency.

We recently closed a multimillion-dollar deal with a major North American mobile operator to calibrate 5G-related millimeter wave frequencies across several U.S. markets. We expect healthy growth in this area over the next couple of years to support this customer and other mobile operators and web-scale companies that are designing next-generation 5G and IoT networks as well as refreshing existing 4G radio access networks in support of new frequencies.

In the enterprise market, Anil noted the opportunity we see to leverage our strength in network performance, to extend into other areas of IT. Last quarter, we won a deal valued at over $1.5 million with a major hotel operator, who realized our NETSCOUT technology to monitor network and application performance tied to its reservation and rewards system.

This win is a vital part of a major IT initiative to consolidate and virtualize the data centers and migrate applications to the cloud following a large acquisition. As part of this activity, this customer is using a combination of our ISNG and vSCOUT offerings to help them baseline system dependencies and achieve pervasive visibility into critical applications across an emerging hybrid cloud environment.

In the security area, Arbor has continued to set the standard for technology and market leadership in the DDoS market. Earlier this month, we announced that the Brazilian Network Information Center, NIC.br, selected Arbor DDoS solutions to strengthen its network operations center-of-defense capabilities to protect its infrastructure against service disrupting distribution -- distributed denial of service or DDoS attacks. The NIC.br is vital to Brazil's Internet infrastructure, registering all domestic .br domain addresses and designating all IP addresses for the entire country.

With DDoS attacks commonplace in Brazil, the NIC.br recognized that it could not afford a disruption in its network resources, so it turned to Arbor to enhance their detection and mitigation capabilities. Arbor's combination of robust scalable detection and mitigation offerings are critical for quickly identifying attacks and then rapidly and efficiently protecting the network from the attack via automation and other tools.

Just a quick comment on our upcoming Engage user conference, which will be held in Dallas, Texas, in 2 weeks. We already have over 800 registered attendees, more than ever before, composed of senior-level professionals across network operations, DevOps, CloudOps and SecurityOps as well as a line of business professionals from well over 300 organizations, representing every major vertical as well as NETSCOUT distribution partners.

With our smart data strategy resonating with the enterprise and service provider customers, we expect that this year's Engage will be a high-impact event for us, and we are looking forward to showcasing our current capabilities and sharing our near-term product road maps.

That concludes my prepared remarks. And at this point, I will turn the call over to Jean.

[Jean A. Bua, executive]

Thank you, Michael, and good morning, everyone. This morning, I will review key fourth quarter and full year metrics for fiscal year 2018. After that, I will review the guidance for fiscal year 2019. As a reminder, this review focuses on our non-GAAP results, unless otherwise stated, and all reconciliations with our GAAP results appears in the presentation appendix. All fiscal year '17 and FY '18 results reflect revenue recognition under ASC 605, and I will cover the potential impact of adopting ASC 606 in just a moment.

Slide #12 shows our results for the fourth quarter of fiscal year 2018. For the quarter, total revenue decreased 27% to $238.5 million. Our gross profit margin improved 150 basis points to 76.7%. The significant drop in revenue impacted operating profit margins, which declined substantially to 17.8%. Our diluted earnings per share was $0.36.

Turning to Slide 13, I'd like to review key revenue trends for the full year. Revenue in our service provider customer segment declined approximately 22%. Nearly 2/3 of the decline was attributable to the multiyear deceleration in spending by one of our large Tier 1 service provider customers. About 20% of the decline was a decrease in spending from all other service assurance provider customers and the remainder was due to a decrease in Arbor's DDoS revenues.

Our enterprise vertical declined by approximately 10% in fiscal year 2018. Revenue for the core NETSCOUT nGeniusONE offerings declined by approximately 5%, due primarily to softness in verticals such as health care and high tech; while larger verticals, such as financial services and government were relatively unchanged against last year. This was compounded by a mid-teens percentage revenue decline for the ancillary products from the former Fluke enterprise network area and a mid-teens revenue decline for Arbor's enterprise security products.

For the full year, the mix of revenue was 53% coming from service provider and 47% from enterprise. In terms of revenue by geography, which is calculated on a GAAP basis, our revenue in the United States declined sharply in fiscal year 2018, due primarily to weaker service provider spending, led by the previously discussed decrease in revenue from that large Tier 1 carrier.

The issues impacting spending in our service provider and enterprise customer segments also affected revenue performance outside the U.S. International revenue declined by 8% overall, with declines in each major international region. International customers represented 41% of GAAP revenue versus 38% last year. We did not have a 10% revenue customer in fiscal year 2018. Revenue from our largest direct customer finished the year at just over 6% of total revenue.

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 securities of $447.8 million, an increase of nearly $65 million from the end of December.

We delivered strong free cash flow considering the operating results. Our free cash flow for the fourth quarter was $69.9 million and $205.9 million for the full year. The conversion of non-GAAP net income to free cash flow was approximately 165%, which was better than anticipated due primarily to favorable changes in working capital, tied to the collection of receivables, lower cash tax taxes and lower capital spending.

For the next year, we would expect that free cash flow will be slightly better than 100% of non-GAAP net income on both an ASC 605 and 606 basis, as we anticipate increased capital spending due primarily to a facility relocation and a return to more normalized working capital levels.

As detailed on last quarter's call and disclosed in our filings, we executed an accelerated share repurchase or ASR of $300 million in early February. In conjunction with this activity, the banks working on our behalf immediately delivered 7.4 million shares of our common stock, which represented approximately 70% of the ASR when the agreement was signed. Those banks have been actively repurchasing our stock since that time, and we currently anticipate that this program will be completed by the early fall at the very latest. Once the ASR is technically completed, the share count will be further reduced by the number of shares actually repurchased, excluding the number of shares reflected in the initial reduction.

We have funded the ASR through additional debt of $300 million, which is supported under our amended and expanded credit agreement that we entered into at the start of the calendar year. We have now drawn down a total of $600 million on our credit facility. We are continuing to work with our board to finalize appropriate long-term targets for our financial profile.

To briefly recap other balance sheet highlights, accounts receivable net were $213.4 million, down by $80.9 million from the end of last year. DSOs were 78 days versus 80 days at the end of fiscal year 2017.

Moving to Slide 15 for guidance. My commentary will focus on the non-GAAP guidance. I'd like to remind everybody that the reconciliation of our GAAP guidance to our non-GAAP guidance is in the appendix.

Today's guidance reflects our adoption of ASC 606, the new revenue recognition standard effective as of April 1, 2018. Although we anticipate that the adoption will constrain our full year reported results, it is important to note that it will not change our customer relationships, sales practices or cash flow.

We currently estimate that there is approximately $26 million of deferred revenue that would have been recognized in fiscal year 2019 under the legacy standard that will now flow through our retained earnings. Of this total, about 2/3 of the revenue is product related, with the majority of it tied to orders for legacy products from the former TekComms unit. This equates to a revenue headwind of approximately 3% for FY '19, which directly impacts our bottom line. We currently do not anticipate any material effect of ASC 606 on our full-year sales cost.

The impact of ASC 606 will vary over the coming quarters. At present, we anticipate that the adoption of this new standard will reduce the first quarter FY '19 revenue by approximately $9 million, with the reduction in revenue of over $7 million anticipated in the second quarter; a reduction of nearly $6 million to the third quarter revenue; and a reduction of the remaining $4 million in revenue in the final quarter of the year.

Using the modified retrospective approach for our reporting, we plan to break out the effect of ASC 606 on our FY '19 quarter and year-to-date result so that you are better able to assess the underlying performance against prior year periods, which were accounted for using the legacy ASC 605 standard.

Anil has already reviewed the opportunities and challenges we see in both our enterprise and service provider customers. Taking those dynamics into account, our fiscal year 2019 revenue guidance ranges from a low single-digit decline to low single-digit growth on a percentage change basis over fiscal year 2018. On a comparable reporting basis, using the legacy ASC 605 standard, this guidance range would equate to FY '19 revenue that would be roughly flat to low single-digit growth.

In terms of our diluted earnings per share for the coming year, our revenue guidance implies EPS guidance of a 20% decline to low double-digit growth. On a comparable ASC 605 basis, this range would be a low single-digit decline to 30% growth.

Key assumption for fiscal year 2019 are outlined on this slide. As you can see, the adoption of 606 is expected to impact reported gross and operating profit margin performance in FY '19. In terms of further color on our annual revenue guidance, we expect modest growth in product revenue, which would help offset an anticipated decline in service revenue.

In terms of revenue by customer segment, it is important to keep in mind that a majority of the 606-related revenue reduction impact, orders with our service provider customer segment. Accordingly, we anticipate that service provider customer segment revenue will decline modestly on a reported basis, which we believe will be offset by growth in our enterprise customer segment.

I'd like to briefly cover our view into the first quarter of FY '19. Factoring in the aforementioned $9 million headwind from the adoption of ASC 606, we currently anticipate that first quarter revenue will represent approximately 21% of our fiscal year 2019 revenue targets. This would imply a mid-single to low double-digit revenue decline on a percentage change basis from the same quarter last year.

We currently anticipate that between 46% to 47% of our expected FY '19 revenue will come in the first half of the year, which is generally consistent with the historical trends of our business.

We are planning for first quarter operating expenses to be between 3% to 5% lower than the same quarter 1 year ago.

Diluted earnings per share for the first quarter is expected to range from a loss of $0.05 to positive $0.04.

That concludes my formal review of our financial results. Before we transition to Q&A, I will mention that Slide 16 details the investor conferences we plan to attend over the next 2 months.

And now I'll turn the call to the operator to start Q&A.

[Operator]

[Operator Instructions] We'll take our first question from Eric Martinuzzi with Lake Street Capital.

[Eric Martinuzzi, analyst]

I appreciate the clarity on the ASC 606, I think that's an important distinction to highlight. I was curious to know just as you talked a little bit about the weakness in FY '18 and the multiyear issue with your largest customer on the carrier side, and then the decrease from other service assurance customers. But I'm wondering, how much of that is form factor related. In other words, the guidance a year ago, as we entered FY '18, did that include maybe a greater percentage coming from a hardware form factor as opposed to the software form factor?

[Anil Singhal, executive]

Yes, I think so, Eric. Yes, there are effect of that. I think the challenge beyond those 2 large 10% customers, which we faced in last 2, 3 years is the effect of digital transformation, that while the industry is going through a transition to more software wait-and-see attitude on spending, moving to cloud and otherwise, we are also reinventing ourselves as a software company, even though a large portion of original NETSCOUT was software-based, but we ship a lot of appliances. So our instrumentation volume has actually generally increased in most segments, but the price per unit has come down. But overall, this is -- this disruption, while it was negative in the past, I think it's going to be a blessing in disguise moving forward. For example, we were never on server firms, because -- and that's why nobody was using our product for application assurance. We were not on remote site. But now because we have a vSCOUT product, which is small form factor, lower in price, we can actually go deep into the data center and into the cloud. So I think the good news, what we are excited about, despite our challenge in the past, I think mostly it's a positive effect of all the stuff we have been doing moving forward.

[Eric Martinuzzi, analyst]

Understand. Sometimes you can learn a little bit about the future strategic direction of a company by the arrival of new directors. You just added 2 today, Al Grasso and Sue Spradley. Does their arrival tell us anything about future strategy for NETSCOUT?

[Anil Singhal, executive]

I think not in terms of strategy, but they are willing to join because they endorse our strategy and they're very excited about it. And Al has a lot of experience on the security side. We are focusing more on the security as the next new product we'll be announcing next month. And so he has -- he is very excited about that. Sue is from the carrier world. So getting some domain expertise on the board, beyond what we already have, will be very helpful. So I would look at it, strategy is not going to change, but it's a validation of strategy that they're very interested in joining. I mean, there is a lot of interest in these kind of board members and they decided to join us.

[Andrew Kramer, executive]

So just wanted to let the audience know that the slides and prepared remarks have been made available, both on the IR landing page and on the supporting materials page of the webcast. So if those who are interested haven't been able to find it, that's where those materials are now located. Operator?

[Operator]

And we can take our next question from Chad Bennett with Craig-Hallum.

[Chad Bennett, analyst]

I guess, either Anil or Jean, in terms of in the product revenue portion of your segmentation, where did we end up in terms of the percentage that was software only or NFV this year in '18? And what are the expectations for that percentage in '19?

[Jean A. Bua, executive]

In 2018, the product revenue ended up in about the upper-single digit, so somewhere between 7% to 9%.

[Anil Singhal, executive]

And I think this could -- I mean again, when we are selling it, we use the decision on software versus appliance versus virtual as the last step on the selling process. We are doing the [ rally ]. So we don't really push customers one way or the other, but this could be as high as 20% this year, but we'll remain -- we have to see.

[Chad Bennett, analyst]

And is it still largely going to be kind of -- the service providers are, obviously, going in an accelerated fashion towards that just networking in general, but are we going to see some of the software transition on the enterprise side of the business too or will that stay really appliance based?

[Anil Singhal, executive]

I think you'll start seeing on both. It was practically 0 on the enterprise side. And -- but as we move more to the cloud, but I think as earlier Eric had the question on some of the impact on the growth in the past was related to people not ready with virtualization and cloud stuff in the mainstream. And as those things are coming mainstream, I think that you'll see a lot of revenue on the software side, not only on the traditional on-prem deployment, but definitely, all the cloud stuff. The vSCOUT deal Michael talked about is all software.

[Chad Bennett, analyst]

Got it. And then, one last one for me. Jean, in the guide for the year, I wasn't sure if the -- I think you guys laid out $50 million of kind of cost cuts that'll be layered in throughout the year. Does the bottom line guide in margins factor that in?

[Jean A. Bua, executive]

No, the bottom line guide does not factor -- the earnings per share does not factor in any of the activities that have not occurred yet, including the divestiture of the tools business and any other cost management activities.

[Chad Bennett, analyst]

Okay. So -- but we're expecting to realize some of -- these are, kind of, planned and ready to the executed on, I guess, the $50 million?

[Jean A. Bua, executive]

The divestiture of the tools business is in process. And based on where we're at this moment, we would expect it would sometime probably be divested during the second quarter. That has about -- that has, as we had put in the script, about 4% of a revenue impact with about the same amount of cost in there. So it should be a negligible effect on earnings per share. The other activities that we discussed related to structure are going to be executed before the end of the second -- of the first quarter. So at the end of our first quarter and in our earnings call for that, we'll update guidance appropriately.

[Chad Bennett, analyst]

Okay, real quick. Share count for the year, Jean, what should we use?

[Jean A. Bua, executive]

For the full year, I think it will be -- right now, I assume it will be around 80 million shares by the end of the fourth quarter. That will assume that the ASR is completed sometime in the second -- in our Q3 and at the share price it is today. If the share price fluctuates, we'll update it accordingly.

[Operator]

We'll take our next question from James Fish with Piper Jaffray.

[James Fish, analyst]

So the DDoS market is having a good growth environment, whether you want to talk about Akamai, Cloudflare and [ indiscernible] or others. However, when normalizing for the pricing changes made last year, the growth at Arbor is still below the market, despite even competitors admitting that Arbor is a great product. Have there been any discussions of possibly spinning out the business so that there can be more focus on it from a pure-play perspective? And also, given the large breaches this past quarter, or at least the memcached attacks, was there a bounce back in the revenues you could recognize at Arbor networks, at least?

[Anil Singhal, executive]

So first thing is, we are the most first -- most focused company to own DDoS. If you look at all other companies, it's just a simple plus 1 thing, whether you're -- all the names you talked about, with the exception of a few. And I think there is the effect of being -- we being the biggest player in the market. And I think there are challenges, but we are moving to a software-based solution. We are using some of the Arbor technology to grow bigger than the -- in DDoS. DDoS market is good, but it's not as big as that one-threat market. So with our focus in this area, we are going to release a product which is a superset of the DDoS product. And it's in the advanced threat space. And there is a packet shaper product I talked about. All this will be talked about at our user group meeting and be available by the end of June. And I think that's how we want to use the Arbor asset, continue to maintain our leadership, but not count on necessarily growth on the DDoS portion, but grow our footprint in overall in the security market. And some of the enterprise growth expectations we have for this year is really because of that reason. And lot of our customers are very interested in this combination of technologies.

[James Fish, analyst]

Got it. And then I think the big question here is if guidance is conservative enough given the last years of kind of initial guides being cut later on. What makes you confident that the business will not be declining worse than the low single digits you're guiding to? And also, while all of your peers are actually getting a slight boost from profitability from ASC 606, you guys are actually guiding that you're not. It only looks like you're guiding for about 15% and 19% operating margins, which would be down year-on-year and yet, the business it's not really growing. Can you walk us through kind of these dynamics as to why it's going this way and that you're impacted this way? And why you aren't further reducing cost beyond sort of the $50 million run rate, given you're only growing flat to low single digits?

[Anil Singhal, executive]

Jean, do you want to go over the ASC thing?

[Jean A. Bua, executive]

I can go over the ASC 600 effect and Anil can answer the other parts of your question. ASC 606, we had from the TekComms mostly projects. As we had talked about in the past, their approach to selling was to sell the product along with implementation and milestones. And so basically, in 606, the revenue recognition for those types of project changed. So the $26 million that we would have reported in Q -- in fiscal year '19, goes through retained earnings. And actually, the total amount is closer to about $35 million. So there's even a runoff in FY '20, just based on the length of the projects. And then there's some associated support models that are changing, that will put those through our retained earnings also.

[Anil Singhal, executive]

With the operating margin comment, our operating margin will be growing.

[James Fish, analyst]

Operating margin would be growing on ASC 605 basis. Obviously, with a $26 million revenue headwind, that is going to impact both your gross and operating margin reported results.

[Anil Singhal, executive]

So adding to your comment about -- we already mentioned that we have been -- we'll be rather conservative in our guidance this year. And one of the reasons we wanted to talk about the long-term growth is saying where we are spending, what do we see the impact and if you look at the long-term stats for -- moving over the 4-year targets, that looks very impressive. And we think that doing more cuts than what we are looking at are really going to compromise that model. And if we find during the year that those things are not panning out, then we will make the adjustment. And second is we are making sufficient cuts, but unfortunately or because of the timing, they will not show impact this year, but you see an impact in the next year and moving forward.

[Operator]

We'll take our next question from Kevin Liu with B. Riley.

[Kevin Liu, analyst]

Just as it relates to 5G, it seems like you guys have a little bit more of a positive outlook in terms of what that can do for your business. What's changed there in terms of the opportunity that you see? And is the growth there really driven more by just a refresh cycle, are you seeing kind of newer opportunities or network capabilities that you're looking to monitor?

[Anil Singhal, executive]

So the items which Michael talked about are really in the pre-deployment state. There's the calibration business. And that's not necessarily our core business. But that shows that if you become incumbent, while we have reinvented ourselves and maintained our leadership despite some of the challenges we saw, but one of the rewards of the incumbency is that you get to play in the next generation. It's not a refresh cycle in terms of replacing all of our instrumentation. I think the bigger refresh cycle is coming from the cloud and virtualization. But knowing that we are in the front of the line because of our incumbency and what we have done allows us to participate in the 5G opportunity. It's not -- as we mentioned, certainly, this year, it's not going to be a big opportunity, but I think with incumbency, it makes us sticky when the 5G revenue comes along.

[Kevin Liu, analyst]

Got it. And then more broadly as you look to your longer-term growth targets, obviously, implies bit of acceleration from this year. To what extent is that driven by enterprise versus service provider and how much of it hinges on some of the new products you're introducing?

[Anil Singhal, executive]

So it's the new technology and new products. So yes, we see higher growth on the enterprise side than on the service provider side. And enterprise growth is a blend of service assurance and security. So we are announcing a product related to 4, 5 products, which all combine together to deliver what we call smart data core. And which is a consolidation play with other security and monitoring tools as well as an expansion to our bigger market beyond traditional NPM and DDoS in the enterprise space where we have had the leadership for many years.

[Operator]

We'll go next to Alexander Kurtz with KeyBanc.

[Alexander Kurtz, analyst]

Just want to follow up on that last question about the long-term targets. I mean we're talking about pretty strong re-acceleration assumptions in the top line to get to mid-single-digit CAGR or better from the fiscal '18 period to fiscal 2022, Anil?

[Anil Singhal, executive]

Yes.

[Alexander Kurtz, analyst]

What -- I mean is that based on a recovery at some of your top [ SD ] accounts? I mean that's expectations for some really strong growth from '18 to '22. So can you just walk us through kind of the step functions to get there?

[Anil Singhal, executive]

Well, first of all is that one of the challenge -- we had some growth here and there in the last few -- couple of years, but because of the massive impact of those 2 providers, those benefits were not seen, but we have been making a lot of progress. And we think that the dynamic which is going to play out in service provider is the price per unit going down is going to be actually positively adjusted by the volume going up. And that's going to be the effect on the service provider side. We are the #1 player and we saw the negative effect of that. And then, for the negative effect of a lower price because of software model, but those 2 effects are behind us. So the negative drag of the service provider will basically stop, starting with this year. On the enterprise side, we have really not played in the securities space. We have played in a narrow portion called DDoS. And people are looking for our solution for the security market. And some of the wide data expertise we have is unique in the industry. And that made us a big player on the application performance and network performance side, but that technology has not been leveraged on the security side by any company like us. And that's what we are excited about. And then we have not done any joint selling of Arbor products into NETSCOUT account. So I think the positive stuff is coming that we could drive 5% to 10% growth. And we could have a big impact on EPS because all other stats are lining up whether it's tax rate, whether it's share count, whether it's margins and we -- yes, we still have to do that, but I think that's a target we can achieve.

[Alexander Kurtz, analyst]

So lower price points in the service provider segment will drive higher volume along with -- maybe along with some recovery in just sort of the core spending with those accounts from where they were, say, 2 years ago.

[Anil Singhal, executive]

Yes, that's right. That's right. And I think one of the other example I give to people is that people are spending more money on Uber and -- than on taxis, even though, price per ride is lower. And that's a digital transformation, but when you are the Uber and the taxi company, which we are, it causes a disruption in the short term. And that's what we have been managing through. So I see a lot of excitement with our customer base. And I think we have to prove it to investors and by this year, that we are on that trajectory.

[Alexander Kurtz, analyst]

Just the last question here. Jean, for the fiscal '19 assumptions, you're speaking to down modestly in the service provider segment for fiscal '19 in your assumptions. Is that double-digit? I mean don't know what modest means anymore for that segment. So how would you -- is there a range you could give us on what that could look like?

[Jean A. Bua, executive]

Probably at this time we really don't give guidance out in detail that way. So I would not want to guide to that level at this time.

[Andrew Kramer, executive]

Clearly, you could have orders that -- Alex, I mean you can have orders that end up skewing service provider just given the lumpiness of some of the opportunities that we're looking at, so.

[Operator]

And we'll take today's final question from Matt Hedberg with RBC.

[Matthew Hedberg, analyst]

Just one from me. In the past, you've noted that enterprise sales cycles may have been lengthening. Some of that may have been due to customers thinking through their cloud footprint software-only deployments. I still think you're having good success there, but I'm wondering, and maybe I missed this in the prepared remarks, but could you comment on how sales cycles trended in Q4? And is there anything you guys can do operationally to shorten that curve and accelerate those sales cycles into this fiscal year?

[Anil Singhal, executive]

I think this -- so one of the biggest things was in the past, I think there are 2 -- at least 2 factors, which are new right now. One is that it's much easier -- we feel that we have the best technology for the advanced threat space, yet we have not leveraged that for the security market. And I think that has shorter sales cycle, more -- less scrutiny than our traditional market. So that's one change. And second is that we are -- we could potentially consolidate other tools in the security space with this Packet Shaper product. So we are less on a mission versus like we had in the past, but more on helping with the customer who already has a mission to spend. And I think that those are the 2 effects which is getting us there. And third is, as we talked about with the vSCOUT win, we were never on certain parts of the infrastructure. We are not in the server firms. We were not in the remote sites and those are the markets we didn't -- couldn't address with the price points we have. With the vSCOUT and some of the new things happening in the cloud, we have access to those budgets now. So all this is creating a dynamic. Obviously, it required couple of years of effort to get to this point. And I think this will have the effect of shortening the sales cycles.

[Operator]

And this will conclude today's Q&A session. I'd like to return the floor to Andrew Kramer for closing remarks.

[Andrew Kramer, executive]

Thank you, Keith. Thank you, everybody, for tuning in this morning. If you do have questions regarding the call today, feel free to reach out to Investor Relations. And we look forward to seeing our shareholders and analysts over the coming couple of months at a variety of investment conferences. Thank you, very much.

[Operator]

And this will conclude today's program. Thanks for your participation. You may now disconnect.