Ladies and gentlemen, thank you for standing by, and welcome to NetScout's First Quarter Fiscal Year 2021 Financial Results Conference Call. [Operator Instructions] Tony Piazza, Vice President of Corporate Finance, and his colleagues at NetScout are on the line with us today. [Operator Instructions] I would now like to turn the call over to Tony Piazza to begin the company's prepared remarks.

Thank you, operator, and good morning, everyone. Welcome to NetScout's first quarter fiscal year 2021 conference call for the period ended June 30, 2020. Joining me today are Anil Singhal, NetScout's 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. You can advance the slides in the webcast viewer to follow our commentary. Both the slides and the prepared remarks can be accessed in multiple areas within the Investor Relations section of our website at www.netscout.com, including the IR landing page under financial results, the webcast itself and under financial information on the quarterly results page. Moving on to Slide 3. Today's conference call will include forward-looking statements. These statements may be prefaced by words such as anticipate, believe and expect and will cover a range of topics that are not strictly historical facts such as our financial fiscal year 2021 assumptions, our market opportunities and market share, key business initiatives and future product plans, along with their potential impact on our financial performance. These forward-looking statements involve risks and uncertainties and actual results could differ materially from the forward-looking statements due to known and unknown risks, uncertainties, assumptions and other factors, which are described in this slide and in today's financial results press release as well as in our annual report on Form 10-K for the year ended March 31, 2020. NetScout assumes no obligation to update any forward-looking information contained in this communication or with respect to announcements described herein. Let's turn to OpEx number four, 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. The rationale for providing non-GAAP measures, along with the limitations of relying solely on those measures is detailed on the slide and in today's press release. These measures should not be considered in isolation from or as a substitute for financial information prepared in accordance with GAAP. Reconciliations of all non-GAAP metrics with the applicable GAAP measures are provided in the appendix of this slide presentation, in today's earnings press release and they are also available on our website. I will now turn the call over to Anil for his prepared remarks. Anil?

Thank you, Tony. Good morning, everyone, and thank you for joining us. Let's begin on Slide 6 with a brief recap of our first quarter non-GAAP results. We delivered strong earnings-per-share growth on a relatively consistent revenue level compared with the same quarter last year. Revenue was $183.8 million in the quarter, approximately 1% lower than the same period last year. Earnings per share was $0.17 in the quarter and an increase of more than 140% compared to the same period last year. Enterprise revenue in the quarter was strong, but was offset by a decline in service provider revenue due to this vertical project-based nature. The quarter benefited from the lower operating costs from continued cost control measures and a decrease in expenses largely attributable to lower sales and marketing costs from reduced programs, events and travel expenditures, primarily due to COVID-19 pandemic-related restrictions. Let's move to Slide 7 for some further perspective as we review business insights. Following our April virtual Engage Technology and User Forum, we continue to experience solid interest in our suite of solutions. NetScout's trust factor is attracting enterprises to our solutions to help solve heightened pandemic challenges, such as remote works, telemedicine, digital transformation and an expanding cyber threat landscape. Our ability to provide service assurance with real-time pervasive visibility and insight, and security solutions that mitigate disruption regardless of our customers' underlying infrastructure is paramount in this environment. The pandemic and the economic environment are driving varying behavior in our customer base with some customers accelerating their investments while others are exercising caution with their purchasing decisions as they evaluate the impact within their own organization. Overall, it appears that enterprise is focused on rightsizing their networks and proactively address potential vulnerability while service providers were a bit more cautious with their…

Thank you, Anil, and good morning, everyone. Slide 10 outlines the areas I will cover. Starting with customer wins for the quarter, one notable win within the service provider vertical was a low 8-figure deal we did with a large international provider with close to 400 million subscribers. This deal is a continuation of our long-standing partnership with this provider, featuring highly advanced use cases, especially in leveraging our subscriber intelligence in planning and marketing their services as well as structuring their partnership relationships with all over-the-top providers, OTTs, and retail channels, just to name a few examples. This win demonstrates the unique role of our ASI dataset in powering two business-critical functions for this operator as well as the value of our continued relationship and incumbency with our customer base. In the enterprise vertical, we continue to make good progress as customers evolve and accelerate their digital transformation initiatives in general and as they deal with the changes in the way they operate their businesses due to the COVID-19 pandemic, in particular. During the quarter, we closed a series of deals amounting to low seven figures in total in one of our largest standing relationships with a healthcare provider customer whose digital transformation and telemedicine initiatives have drastically accelerated because of the pandemic. Our service assurance solutions are deployed at cloud connect edges in this application, in so-called carrier neutral service facilities, or co-los, to monitor and troubleshoot cloud resident telemedicine applications, whose use significantly increased with the shift to virtual doctor doctor's appointments and patient care. The funding for the deals came from the organization's emergency COVID-19 budget and demonstrates our value as technology turns occur and accelerate as well as the strength of our incumbency and long-standing relationships. During the quarter, we also received a mid-7-figure order…

Thank you, Michael, and good morning, everyone. I will review key metrics for our first quarter. As a reminder, this review focuses on our non-GAAP results, unless otherwise stated, and all reconciliations with our GAAP results appear in the presentation appendix. Slide 12 details our results for our first quarter of fiscal year 2021. Revenue declined 1.2% over the same quarter in the prior year to $183.8 million. Product revenue declined 5.3% and service revenue grew 1.5% over the prior year's quarter. Our first quarter fiscal year 2021 gross profit margin was 74.6%, slightly lower than the same quarter last year. Our software-only sales were 36% of service assurance product revenue as compared to 25% in the same quarter of the prior year. Quarterly operating expenses decreased 8.3% from the same quarter in the prior year, primarily due to continued cost controls and reduced cost for sales and marketing programs, events and travel, primarily due to COVID-19 pandemic-related restrictions. We reported an operating profit margin of 11.2% compared with 6.5% and diluted earnings per share of $0.17 compared with $0.07 in the same quarter in the prior year. Turning to Slide 13, I'd like to review key revenue trends for the first quarter. In the enterprise customer vertical, revenue grew 21%, while the service provider customer vertical declined 20.4%. Approximately 57% of total revenue was generated from the enterprise vertical with the remainder from the service provider vertical. Turning to Slide 14. This shows our geographic revenue mix on a GAAP basis. The geographic split between domestic and international was consistent with the same period in the prior year. Additionally, there were no customers that represented 10% or more of revenue in the quarter. Slide 15 details our balance sheet highlights of free cash flow. We ended the quarter with…

[Operator Instructions] We'll take our first question from Matt Hedberg of RBC Capital Markets.

It's Dan Bergstrom for Matt Hedberg. Say, the enterprise sounded strong, revenue up 21%. Just trying to gauge the strength here. How much do you think was related to ongoing digital transformation, cloud migration, security initiatives versus, say, some acceleration or pull forward to address potential network vulnerabilities during the current environment here?

I think the bulk of it is still for cloud transformation and traditional projects. But yes, there was some acceleration of needs because of people working from home, which makes the VPN link very important, both from a security and performance point of view. And we are not able to carve out the exact numbers because our product has multi-use, but definitely what's happening right now had some impact, both on the security front and the performance front in the enterprise.

And then could you talk about trends and maybe pipeline built through the quarter? Any changes in demand or easing in project funding as the quarter progressed? And then perhaps thoughts around activity in July, any way to contrast it against June or perhaps previous Julys?

I think, well, what this previous July, I think in the service provider, we see continuing challenges. I think last year was much better for us, you are right. Again, as we mentioned, the timing of the project makes the quarterly numbers very skewed. But overall, I would say there is a slightly better pipeline build in the enterprise area and slightly worse on the service provider side versus last year.

We'll move next to James Fish of Piper Sandler. Your line is open.

And Michael, Dan actually stole a couple of my questions there. But how have conversations with your major carrier customers been regarding that timing of 5G core deployments. And can you remind us the difference in typical deal sizes between the radio access side versus the core for you guys?

Well, I think the overall the we always have been saying that 5G opportunity is more longer-term, and that's not significantly changed. But we always also said that the major investments are required right now. So it's interesting that we have to be able to make major investment, which compared to our competitors, we are in a position to do. But a lot of the product is being used to get a network up and running because there are not many subscribers. And we sell based on the bandwidth, there's not a lot of money on 5G. But one other thing I wanted to mention, even though you didn't ask that particular question, the 5G is significant in other areas, including private 5G, so our investment will pay off in the federal government and enterprise also. For example, Mercedes-Benz have their own spectrum. 5G slicing will be used by enterprises. So I think this 5G investment may not bring any short term revenue. And but in the long term, it will make us a stronger company after we come out of the pandemic. And we cannot measure that in terms of the pipeline or revenue right now, but in terms of leadership begins, I think that's going to have a big impact.

And Jean, maybe for you on sort of the OpEx side, how should we think about the savings that you guys had or at least the kind of cost controls you guys had in the quarter here related to not traveling and sort of the pandemic that we're going in? In other words, what's not sustainable for you guys moving forward that we should expect should come back into the model at some point?

Sure. I think our internal plans going forward surrounding returning to travel for the sales force, and particularly investment in marketing, as Anil had talked about to make sure that our brand is fully recognized through all organizations. Probably would mean that in the second half of the year, during Q2, we plan to ramp a lot of those sales and marketing-related events. In the quarter, obviously, there was some travel that didn't happen. So I'm going to estimate probably a couple of cents in earnings per share, maybe $0.02 to $0.03 in earnings per share or reduced travel and some reduced marketing spend.

I don't know 8 RMB. So we just wanted to make one comment. I think that there's a permanent shift toward hybrid or virtual events and live events, which are very expensive and not very productive are generally taking a back seat. And I think that is a big shift that's going to persist.

We'll move next to Eric Martinuzzi of Lake Street. Your line is open.

Yes. So I wanted to talk about the service provider segment. I understand the 5G color or commentary more in the long term, less in the short term. But you talked, at least in the press release about timing issues and then budget challenges just from looking at the AT&T and Verizon commentary, so North America commentary. It seems like the CapEx budgets for them were unchanged coming out of their most recent quarterly commentary. So curious to know is that, that you're just getting you're not getting a piece of their unchanged spend? Or is it something else within timing or budget challenges that I'm not understanding?

Well, I think that, Eric, as you know, the budget challenges have been there forever for last, I would say, last three, four years on the 4G side. And 5G at this early stage is not able to mitigate or compensate for them. And then we have consolidation. So I mean, we are the top provider in U.S., which are big customers of NetScout and a substantial portion of the revenue, they're having all of them having different kinds of challenges. And so I think some of that is those challenges continue. And until 5G revenue is coming for them, which will only happen when they have sufficient number of subscribers. Right now, we are you have single-digit in that subscriber base, even and that's also for one or two providers. So I look at service provider environment even after 5G to be somewhat challenging. But right now, in the short term, even 5G is not having an impact. There is a lot of work. We have to continue to make the investments so we come out stronger, as I said earlier. But there's no significant revenue. The projects have to be in the analytics area. Taking 4G data for machine learning and AI-type stuff. And one other thing I wanted to point out, which has a little bit impact on enterprise also, but also on the service provider, is that we announced several things at our Engage event. Some were enhancement to existing solutions, software upgrade but other were brand new products, It's very tough to for our customer to evaluate brand-new products right now because we have somebody has to go there, do some installation. So I think some of the things, which were we might have been counting on for this year in January, I think it's going to be delayed. And but our leadership will still continue as a result of the awareness of what we are doing.

And then for Jean, I know you're not giving guidance either for the fiscal year or for Q2. But historically, we would see seasonally, NetScout Q2 total revenue was up versus Q1. And then services revenue was up sequentially. Do those do both of those historical trends hold even though you can't give us numbers?

I mean, the pattern that you described is the pre-pandemic pattern. Sorry, just took How does that you described yes, the pre-pandemic pattern, and you're 100% correct. In Q1, which is the beginning of our fiscal year, we always have the lowest amount of revenue and it grows and product revenue based on Q2 being the traditional end of the fiscal year for federal government. And then Q3 and Q4, the budget transitions where people are using their current calendar year budget and/or in or Q4 using their current new calendar year budget. I would say that with the pandemic and our revenue being relatively consistent, that what we see in the pipeline, we would hope that, that continued pattern would exist. But it would probably be somewhat muted between Q2 to Q1, just given some of the assurance and DDoS sales that we saw in the beginning of April that wanted customers to be able to strengthen their network and make sure they were having good performance and good security.

Okay. And then the services line, could you respond to that?

The services line, I would say, it probably continues to grow slightly over the course of the year. Obviously, as you know, it all depends on the economic recovery and where the product revenue and projects continue to occur for us and then that mitigates some of the growth, either positively or negatively in service revenue.

Our next question is from Kevin Liu of K. Liu & Company. Your line is open.

As it relates to the seasonality, could you talk a little bit more about what you're seeing in the government vertical right now? And whether you do actually expect that budget flush to occur in the September quarter?

Well, I think the activity level is Kevin, is very high. Like last year, we have a lot of projects. But we were just talking about before the call that as we hear from sales team, there's a lot of uncertainty because of the election year and other things going on. But yes, we have a lot of projects, but we do get these orders. We did get some big ones last year, but we are cautiously optimistic this time because there's some additional uncertainty factors.

That's helpful. And then it sounds like you're starting to get more traction with sales Arbor into the enterprise base. Maybe talk a little bit about the penetration rates you currently have? And any sort of goals you might have as we exit the year here?

Well, one of the big things we were counting on this year as we merge the Arbor sales were we have the overlay function now. So we were planning to introduce some of the Arbor products into the enterprise. And that's going to be slowed down because if it is going to a customer who has never seen that product before, then we can't evaluate and do effective POCs because you have to ship a unit there. And so that effect, which we would have happened positively this year won't happen. But on the other side, as people are working from home, we happen to have a solution, which is always good for monitoring the VPN and securing the VPN, but that was not interesting problem until now or it became more interesting problem. So we see some upside because of that, which is reflected in what happened last quarter and this quarter. At the same time, some of the plans, which we had for cross-selling probably will be delayed.

Our next question is from Nick Mattiacci of Craig-Hallum.

This is Nick Mattiacci on for Chad Bennett. Just on the software penetration of overall revenues, I guess, how should we think about the growth rate there throughout this year? And what kind of impact should that have on gross margins?

So the software penetration going forward is always a factor in what the customer prefers to buy-in. And I think as what form factor they prefer to buy-in. And I think that when you think about our penetration of software-only into especially the enterprise, where you have interest in our products for future 5G-related network, as Anil talked about, or where they want to do more monitoring at the edge, which is very important. I can think over the year that the penetration will probably continue to increase, especially given how fast you can deploy the software and the efficiency from a cost perspective, also in being able to purchase the software and install it very rapidly. So I would imagine, if I look over the year, last year, FY 2020, our total penetration was about for the entire year, was about 30%. So I would see it being north of 30% in FY 2021. I think, Anil, in the past has said that over time, it will probably get to about 50% of our product revenue of service assurance. And just to remind everyone that our software nature in the product revenue is much higher than the number that we give out. This is the number this is the percentage of customers who are transitioning from an appliance-based form factor to a software-only form factor.

There are no further questions at this time. I'd be happy to return the call to Tony Piazza for any concluding remarks.

Great. Well, that concludes our call. We appreciate everybody joining us this morning. We look forward to speaking with some of you at some of the virtual investor events, and I hope everybody enjoys the rest of the summer and stay safe. Thank you.

This does conclude NetScout's first quarter fiscal year 2021 financial results conference call. You may now disconnect your lines. And everyone have a good day.