F5 Inc (FFIV) 2013 Q1 法說會逐字稿

Good afternoon, and welcome to the F5 Networks first quarter financial results conference call.

At this time, all parties will be able to listen only until the question-and-answer portion.

Also, today's conference is been recorded.

If anyone has any objections, please disconnect at this time.

I would now like to turn the call over to Mr. John Eldridge, Director of Investor Relations.

Sir, you may begin.

Thank you, Angie; and welcome, everyone, to our conference call for the first quarter of fiscal 2013.

The speakers on today's call are John McAdam, President and Chief Executive Officer; and Andy Reinland, Chief Financial Officer.

Other members of our executive team are also with us to answer questions following their prepared comments.

If you have questions following today's call, please direct them to me at 206-272-6571.

If you don't have a copy of today's press release, you can get one from our website, F5.com.

In addition, you can access an archived version of today's live webcast in the Investor Relations Events Calendar page of our website through April 24.

From 4.30 PM today until midnight Pacific Time January 24, you can also listen to a telephone replay at 800-695-3640 or 402-220-0318.

During today's call, the discussion will contain forward-looking statements that include words such as believe, anticipate, expect, and target.

These forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from those expressed or implied by these statements.

Factors that may affect our results are summarized in our quarterly release and described in detail in our SEC filings.

Before we begin, I want to remind you that F5 has no duty to update any information presented in this call.

Now, I will turn the call over to Andy Reinland.

Thank you, John.

Q1 marked a quarter of focused execution within a challenging macroeconomic environment.

Against the backdrop of our typical fiscal Q1 seasonality, we delivered our 15th-consecutive quarter of sequential revenue growth, reporting revenue and earnings results within our guided range.

Before I discuss specific results for the quarter and our outlook for the second quarter, I would like to remind you that non-GAAP numbers exclude stock-based compensation expense and amortization of purchased intangible assets.

A reconciliation of GAAP to non-GAAP results is included in our press release.

For the first quarter of fiscal 2013, revenue of $365.5 million was within our guided range of $363 million to $370 million, an increase of 1% from the prior quarter and 13% year over year.

GAAP EPS of $0.88 per diluted share and non-GAAP EPS of $1.14 per diluted share were within our guided ranges.

Product revenue of $204.7 million grew 4% year over year and represented 56% of total revenue.

Service revenue of $160.7 million grew 28% year over year and accounted for 44%.

Q1 revenue from our application delivery networking business was $359.9 million, and revenue from our ARX file virtualization business was $5.5 million.

Book-to-bill for the quarter was less than 1.

Accounting for 58% of the total, revenue from the Americas grew 12% from the first quarter of fiscal 2012.

EMEA, which represented 23% of revenue, grew 22% from the first quarter of last year.

APAC accounted for 14% of revenue and grew 16% year over year.

Japan revenue declined 11% from a year ago and represented 5% of total revenue for the quarter.

Representing 23% of sales during the quarter, Telco was our strongest vertical, followed by financial at 20%; technology 13%; and total government was 11%, including US Federal, which accounted for 5% of the total.

In Q1, we had three greater-than-10% distributors, Avnet, which represented 16.9% of total revenue; Ingram Micro, which accounted for 15.2%; and Westcon, which accounted for 11%.

Reflecting a record contribution from software sales, our GAAP gross margin in Q1 was 83.3%.

Our non-GAAP gross margin was 84.4%.

GAAP operating expenses of $195.5 million were within our target range of $193.5 million to $198.5 million.

Non-GAAP operating expenses were $171.7 million.

GAAP operating margin was 29.8%.

Our non-GAAP operating margin was 37.4%.

Our GAAP effective tax rate for Q1 was 37.2%, and our non-GAAP effective tax rate was 34.5%.

Turning to the balance sheet.

Cash flow from operations was $145 million, contributing to total cash and investments of $1.29 billion at quarter end.

DSO at the end of Q1 was 51 days.

Inventories were $18.7 million.

Capital expenditures for the quarter were $7.8 million.

Deferred revenue increased 26% year over year to $480.6 million.

We ended the quarter with 3,125 employees, an increase of 95 from the prior quarter.

In Q1, we repurchased approximately 555,000 shares of our common stock at an average price of $90.02 per share for a total of $50 million.

Approximately $131 million remains authorized under the current share repurchase program.

Now for the Q2 outlook.

At the end of Q1, we began shipping several of the new hardware and software products we will be announcing over the next several weeks.

We believe these new additions to our product portfolio will have a positive impact on our Business, as demand for the new products builds throughout fiscal year '13.

In addition, we have continued to gain momentum with our security and service provider solutions, and we anticipate continued solid growth from our services business.

As a result, we believe that we will achieve sequential revenue growth for the remainder of the fiscal year and reaccelerate product revenue growth in the second half of the year.

For the second quarter of fiscal 2013, our revenue target is $370 million to $380 million.

We expect GAAP gross margin in the 83% range, including approximately $3 million of stock-based compensation expense and $1 million in amortization of purchased intangible assets.

We anticipate GAAP operating expenses in the range of $198 million to $205 million.

This includes approximately $25.5 million of stock-based compensation expense.

The recent extension of R&D Tax Credit by Congress will have a favorable impact to our tax rates in Q2, driven by a one-time retroactive catch up for fiscal 2012.

For Q2, we are forecasting a GAAP effective tax rate of 32.5% and a non-GAAP effective tax rate of 31%.

We anticipate tax rates for the remainder of fiscal '13 to normalize closer to 36% for GAAP and 34% for non-GAAP.

Our GAAP EPS target is $0.93 to $0.96 per diluted share.

Our non-GAAP EPS target is $1.21 to $1.24 per diluted share.

We plan to increase our headcount by approximately 100 employees in the quarter.

We estimate DSO will be in the upper 40-day range.

We expect inventory levels within a range of $18 million to $20 million, and we believe our cash flow from operations will be in excess of $95 million, reflecting the large sequential increase in our federal tax payments that is normal in our fiscal second quarter.

With that, I will turn the call over to John McAdam.

Thanks, Andy, and good afternoon, everyone.

I was very pleased with the F5 team performance in Q1.

We delivered year-over-year growth of 13%, continued to strengthen our balance sheet with strong cash generation and an increase in deferred revenue, and made significant progress in product development by introducing a range of new products with the goal of reaccelerating product revenue growth as well as increasing our solution portfolio and the addressable market for our products.

From a geographic perspective, we experienced mixed results in our major regions.

Business in the Americas region, excluding US Federal, delivered solid sequential sales bookings growth over Q4.

However, we saw significant sequential decline in sales bookings from US Federal business.

The US Federal sales in Q1 were below our normal seasonal trends and below our internal forecast.

We believe the reason for this decline was directly linked to the uncertainty caused by the fiscal cliff discussions.

The sales pipeline in our Federal business remains very strong, and we feel very confident about our future opportunities in this market.

Both EMEA and Asia Pacific also delivered sequential sales bookings growth over Q4, with several large wins in each of these regions.

In Japan, we experienced a significant year-over-year sequential drop in sales bookings.

The booking forecast was reduced during the quarter as well -- as the well-publicized fiscal situation in Japan deteriorated.

Japan, in particular, still has a large percentage of sales fulfilled by the mid to lower end of our appliance range of products.

We believe Japan should benefit substantially from the product refresh I will talk about in a moment.

We had some really good sales wins last quarter when we replaced existing Cisco ACE products with F5 solutions, including three ACE replacement wins in Fortune 50 companies.

Our percentage of new business in Q1 was up 6% to 46% last quarter, driven by ACE replacement wins globally.

We set another record for software sales in the quarter.

Software module sales continued their strong growth, and sales of our software-only virtual addition products set a new record high with some $1 million orders in the quarter.

Once again, our security solutions produced strong year-over-year growth driven by continued strength in the security module fields, especially with our application firewall ESM module.

We also made good progress with our Diameter solutions from the Traffix Systems acquisition with some good, competitive LTE project wins.

Service providers are moving to LTE architectures on a global basis, and we believe this trend gives F5 the opportunity to increase our strategic footprint with these operators.

We have come to expect stellar results in our Services business, and these results were again delivered in Q1, with 28% year-over-year growth and a 26% increase in deferred revenue compared to Q1 last year.

We talked in some detail at our Analyst Investor meeting in November about the large array of new products and software solutions which we will be shipping during fiscal 2013.

Our development team made fantastic progress last quarter in meeting their development milestones to deliver a significant new release of TMOS, referred to internally as Solar, as well as delivering a number of new ADC platforms.

The Solar release ships with approximately 76 new areas of functionality for TMOS, including the debut of our advanced application delivery firewall solution; enhanced virtual solutions with the industry's broadest hypervisor support; deployment options to support physical, virtual, and hybrid environments; and our new service provider solutions of carrier-grade network address translation and policy enforcement module with deep packet inspection.

Our policy enforcement module allows BIG-IP to inspect and classify application of protocol traffic and dynamically enforce service provider policies.

For example, our policy enforcement module supports the Gx interface, enabling interoperability with a broad set of PCR apps and our own Traffix Signaling Delivery Controller.

Development has also made great progress, from a platform perspective, delivering a range of new products.

You may recall that we started shipping the first of these new platforms last quarter when we announced the BIG-IP 4200v platform.

Our goal is to refresh the current product line with a new range of products that provide significant price-performance advantages with increased functionality.

We were very pleased with the initial demand for the 4200v in Q1, which was above our original forecast.

We believe this bodes well for the new range of products now available this quarter.

The additional new products now available include the new eight-blade VIPRION 4800 chassis, which handles performance levels well above any other products in the industry.

Also introduced on the new VIPRION blades, our new FPGA hardware-based security capabilities that significantly increase the performance of VIPRION to defend against specific types of denial of service, or DDoS attacks, while allowing the system to maintain an extremely high level of throughput.

The new [seize] of the BIG-IP platforms introduces industry-leading performance as well as firsts such as 10-gigabit interfaces on the low end and 40-gig interfaces on the high end of the lineup.

These new ADC platforms enable the dynamic use of IT resources through F5's innovative ScaleN technology.

ScaleN allows customers to elegantly enhance their application delivery infrastructures by adding capabilities as business needs grow.

Unlike competitive approaches, ScaleN does not require extra hardware or customers to disable features to use it.

This enables organizations to simplify their IT infrastructures and make their technology investments more efficient and cost effective.

As far as the outlook is concerned, Andy indicated that we expect to see sequential growth this quarter.

As I mentioned earlier, we saw a very cautious spending environment last quarter, especially in our Japan and US Federal business.

However, looking forward, we believe that we have significant revenue growth opportunities starting this quarter, and these opportunities should increase our momentum as we enter the second half of fiscal 2013.

We are now at the initial phase of one of the most significant product line refresh opportunities that we have had in several years.

Product training is underway and will continue over the next few weeks to ensure our sales force and channel partners maximize the advantage of these new products.

Also, as mentioned earlier, we are seeing good momentum with sales of our software-only and hybrid software system solutions.

We expect this momentum to continue with the expansion of our industry-leading range of hypervisor support.

These solutions can now support customers' data center and cloud environments with unprecedented performance.

Our virtual software ADCs now include cloud solutions based Amazon Web Services and VMware vCloud Suite as well as Microsoft Hyper-V, Xen, and KVM Linux.

We also believe the new Solar release of TMOS significantly expands our addressable market; in particular, the new Application Delivery Firewall Solution gives our enterprise and service provider customers the ability to integrate essential security capabilities and protect their applications, data, and users.

F5's Application Delivery Firewall Solution is the first in the industry to combine DDoS protection, network firewall, application security, access management, and DNS security, with traffic management, while maintaining industry-leading performance and scalability.

We also see market expansion opportunities in the service provider market with our new carrier-grade NAT solution, policy enforcement module, and our Traffix Systems Diameter solutions for LTE deployment.

In addition, TMOS has been engineered to operate in an SDN infrastructure, dynamically enabling application-level layer-three to layer-seven services.

TMOS provides true separation of data, control, application, and management planes, enabling our customers' smooth migration to SDN.

For example, with the introduction of new capabilities later this year to our BIG-IP and our BIG-IQ platforms, customers will be able to seamlessly manage applications in both VXLAN and NVGRE-enabled environments and leverage sophisticated automation and applications control capabilities through our new iControl API extension, Cloud IQ API.

Finally, we believe there is a real growth opportunity for F5 in replacing the large base of existing Cisco ACE solutions.

As I mentioned earlier, we had some great ACE replacements wins last quarter, and the pipeline of business for this opportunity is very strong.

F5 has a unique and stellar track record of replacing Cisco ADC products in Fortune 500 accounts over the last several years.

The timing of our new ADC platform availability is ideal for us to exploit this opportunity.

Clearly, I feel very optimistic for the future prospects for F5.

I would like to take this opportunity to thank the F5 team and our partners and look forward to continued support for the rest of the year.

With that, we will now hand the call over for Q&A.

(Operator Instructions)

Brent Bracelin, Pacific Crest.

John, really wanted to focus in on the appliance refresh.

Could you frame for us the volume -- where the bulk of the volumes within the appliances are coming from?

4200 was shipping in the quarter, is that the high-volume product?

Or, how should we think about the two additional appliances that you will be shipping this quarter -- the 2,000 at the low end and the 10,000 at the high end?

Does that provide you more coverage?

And, as you think about the competition in that environment, are those important products that should give you a little more cover relative to competitors and refreshing those appliances?

Any color there would be very helpful.

Absolutely.

The 4200v is the lower end of the midrange, so not quite -- it's a workhorse product, but it's not quite the volume product in either actual volume of units or in revenue, but it's a very important product.

I don't want to put it down, it's very important.

The big volume products, certainly from a unit-perspective, also nontrivial from a revenue perspective is the entry-level product.

That's been the case for many years, and we think it will continue.

The 2000 Series -- because we are talking about more than one model here -- is very significant, especially with things like 10 gig and areas like that that I can talk about, or maybe Kyle could talk about, if you want more detail there.

And then, of course, at the high end of the appliance range, we have set the bar even higher with the 10200, which is -- so these are really important products, very significant ones.

Very helpful.

As you think about the competition, where do you think you need the coverage?

Is it really the low end where you felt a little pain the last six to nine months, and that's really the product that we should focus on going forward as a potential reacceleration growth?

I think with the ScaleN technology, with the ability to do more modules, quite honestly, I think all of our products are going to be pretty hot because of that price-performance change.

But, if you were going to ask me where probably where our most weak is -- it is probably the low end.

I would agree with that.

Great, thank you.

Just one quick one on Cisco ACE.

You had three ACE wins in Fortune 50, did you recognize revenue on those any of those three ACE wins in the quarter?

Are those wins that you would expect to see revenue on in the March timeframe?

It's actually yes and yes to most of that.

I don't want to be 100% certain because it's always about forecasting and you need to be careful with forecasting accounts.

We saw revenue last quarter; and given the opportunity, we will probably see that increasing.

That's the whole point about getting into the Fortune 50 accounts, or Fortune 500, for that matter.

Fair enough, thank you.

I will cede the floor.

Matt Robison, Wunderlich.

Can you comment if you've got rev recognition yet for the policy enforcement, and maybe give us an update on DevCentral users?

Yes, policy enforcement is part of the Solar release that Kyle's team, basically, meet their milestones and have it ready for the end of last calendar year.

So, in truth, most of that Solar stuff is this quarter.

It is this quarter and beyond.

And, we would expect to see sales of that.

It's very new, it will take a while to ramp up, take some training, as all software does -- by the way, we expect platforms and sales to be much faster because they can run, not just in Solar, but also in previous releases like the 4200 could and the VIPRION 2400.

With software, we want to be a little bit cautious with you, and it does take some time to bleed through market, but we would expect to see sales wins.

Yes, and -- by the way, Matt, this is Karl.

One thing I would also mention with the PEM module, the customers tend to have a longer -- since they are service provider customers, tend to have a much longer qualification cycle, where they have to go through and run the different applications and whatnot in their environment.

So, the ramp rate of that will tend to be different than, necessarily, some of our other features like security and other things on our platforms.

If it is part of Solar, then it comes with maintenance agreements and -- I would expect, right?

Absolutely.

Is there any specific hardware that needs to be in place to invoke the policy enforcement -- the TPI capability that's required for that?

With the PEM module, obviously, our VIPRION platforms and our higher-end platforms.

Right now, we don't support it on the low end of the range, yet, because it is very much focused on the service provider market.

Yes, so the VIPRION platforms that are available now can do it?

That's correct.

And, an update on DevCentral users?

Sure, Matt, this is Dan.

At DevCentral we finished out the quarter just over 116,000 members.

We see great growth continuing there; and just one thing I'd highlight as well, some of the activities that we are doing things -- Guru Panels, for example, to get the word out.

We are seeing great traction on things like our ACE replacement Guru Panel and expansion into DNS services as well.

So, not only DevCentral user count, but participation in some of these things are growing in a great way.

Thanks a lot.

I will let somebody else who has a question in.

Ehud Gelblum, Morgan Stanley.

Quick question on Westcon, as they are now a 10% customer, were they -- can you give us a sense geographically, was that mainly a US account, or were they more international?

Was the growth there responsible for most of the uptick in services, or was that just coincidental?

Ehud, to the first part of your question, so Westcon has long been a distributor of ours, just did not hit that 10% threshold.

Then, about six months ago, you might recall a press release where we named them, really, our first true international distributor.

So, the balance of that revenue -- I don't have the specific breakdown, but it has gone over that 10%, principally driven by international revenue.

And, I didn't hear the second half of his question.

Basically, I was following up on that.

As they peaked through the 10% mark from where they were before -- and we always knew they were significant, but obviously, they were in the 7% to 8% range or so.

Was that the difference in the quarter?

Or, was it coincidental that they happened to break through the 10% --?

I would say was more coincidental.

Yes, definitely coincidental.

There is no link to any specific products here, or vertical, or geography.

Okay, helpful.

With guidance, with book to bill less than 1, how should we be reading the product versus services split as we look at guidance for next quarter?

Should we be looking for product revenue on a sequential basis to again be flat to perhaps down a little bit with services making most of the difference, given the book-to-bill?

Or, should we start seeing products starting to move up on a sequential basis?

When we give our guidance, we always assume book-to-bill equal to 1, so I think you can look at our guidance from that perspective.

And, the strong message I want to reiterate here, though, is we really expect to see, as we go into the back half of this year, Q3, Q4, that's where we really are going to look to see reacceleration of the product revenue growth.

Okay.

Finally, on Japan, what is your expectation on Japan for next quarter?

You said most of the issues were in the low end, I would imagine there are some competitive issues there.

Is that now shipping and fixed to the point where you could start seeing that starting to rebound?

Is that an area that we can look -- if we don't have much faith in US Federal in the near-term, is Japan an area that can start recovering sooner, more in the next quarter or the quarter after?

Yes, we are being cautious on that, Ehud -- this is John.

It is clearly in the forecast, but we're been pretty cautious with that.

Dave, do you want to comment on what we saw last quarter?

Yes, I think we saw a pretty tough macro environment, not only from end-user customers, but even with our partners as well, that we just saw pretty much as the quarter went on towards the end of the quarter, really, business stopped.

We're looking at a little better quarter this quarter in Japan, but it's still going to be a challenge.

So, you don't think it was a competitive issue, you think is was completely the macro and the new --?

We really -- Dave really pushed in that during the quarter, Ehud -- you never really can be 100% certain, but the feedback we got back from the team -- and by the way, we have got a lot of confidence in the Japan management and the team, was that they really saw some real fiscal issues.

Okay, a lot of stuff has been going on there, so makes sense.

Okay.

Appreciate it.

Jess Lubert, Wells Fargo Securities.

A couple of questions.

First, I was hoping you could help us understand what drove the weakness in the technology vertical?

The business has declined year over year in four of the last five quarters.

So, I would be curious to understand -- are customers waiting for new product?

Is there a competitive issue?

And, to what extent do you believe this vertical is likely to improve in future quarters?

Sure, Jess, this is Dan.

On the tech-vertical issue, you're right; the technical vertical has trended down over the past several quarters for us.

We believe it is driven, really, by a couple of our larger customers that are taking alternative architectural approaches in terms of how they are building things.

Generally, what is going on is they've got one primary application, and they are building some basic functionality into that app.

So, we've been seeing that going on; and obviously, we're doing something about it.

We've got projects going on, internally, that we believe will provide this type of customer with ways that will make it easier for them to integrate our functionality into the application stocks that they've got.

And, just to be very pointed, we don't see competitive at all.

It is more that they're definitely seeing architectural in-house changes.

Does that business linger around this level the next couple of quarters until you can implement some of these new solutions, and it ramps back up?

Is that the right way to think about it?

That's probably the assumption we are making at the moment.

Then, I did want to touch base on the carrier business, how you're thinking about that going into 2013?

Clearly, a better quarter here.

Several major Tier-1 providers have suggested they are going to spend more in 2013 than they did in 2012.

So, I'd love to get some of your thoughts on what you're hearing from some of the major service providers.

If you have seen a change of tone, or an uptick in activity that has you more optimistic about the carrier business as we work through the year.

Jess, this is Manny.

Just to comment on that.

We're seeing a lot of excitement based on the solution set that we're bringing out to the market.

It's primarily driven by a couple of factors.

As we all know, there's huge amounts of demand, today, around the mobile space.

So, what we have been organizing and orchestrating over the course of the last year is really a set of solutions for mobile and fixed operators that really begin to deliver advanced capabilities in terms of traffic management and being able to send to the subscriber as what the application is, and then being able to make policy decisions around that.

So, as we take these architectures out to these customers, they are very interested in various different solution sets, so we think we are going to have a very strong second half.

But, to the point that Karl made, a lot of this new technology we introduced in the market, or we are introducing over the coming couple of weeks, is going to go into trial environments, and it is going to have to go through validation.

And, this will be our PEM module, our Carrier-Grade NAT modules, our advanced traffic-shaping and traffic-steering capabilities, as well as [continuing] with our Traffix Solution sets, or our Diameter solution set in the market.

Would you expect the Telco business to grow faster than the enterprise business in fiscal 2013?

Possibly.

We've had this question so many times of the last couple of years, and I think you'll see quarters where it is more lumpy than others and it's just lumpy and I think clearly will we will see tick up a little bit.

It's certainly -- it's a key vertical for us and we've got -- when we look at the products we are bringing to market, especially in the software side of things with the application firewall and with PEM and with Carrier-Grade NAT and Diameter, there is more of an array of products, but there is going to be some lumpiness.

I think over time, yes, but I wouldn't like to talk about that in the next two or three quarters.

One additional comment, Jess, we are going to be at Barcelona, and obviously, at Mobile World Congress, and really rolling out these solution sets broadly, and around three key tenants -- one is optimization of these carriers' networks.

The second is around the modernization, so they can continue to monetize additional service offerings.

And, the third is around security.

Security is becoming a very important topic for all of the mobile operators out there.

We have some interesting solutions coming out and look forward to sharing those with you.

Thanks, guys.

Mark Sue, RBC Capital Markets.

Gentlemen, I was wondering on product transition, do you think any customers might have paused ahead of the new product launch?

And, any thoughts on cannibalization, and I sense some of your lower-end products have so much more performance for the price than some of your mid-range products in the past?

On the potential [osborne] or delay effect, it is so hard to really put numbers around that.

You may remember, Mark, at the Analyst November Day, we did point out where we saw one or two instances -- EMEA was used as an example.

We haven't seen a lot of that, anecdotally, to be fair.

But, it is a really difficult thing to judge because the customer may not tell you that they are waiting because we have been fairly public about these.

So, we will see.

We think we are going to see a very good reaction given what happened with the 4200 and given the fact that they can run it on Solar or in the previous release, so they can move quite quickly.

I wouldn't like to make a big statement about it because it wasn't obvious to us.

What was the other?

In terms of the performance, you're asking about performance and the impact of the low-end to the mid range.

One thing that we think about with these platforms is that we increase performance also to increase the ability of these platforms to run the modules.

So, we want it to do that, well a byproduct of that is you increase throughput and transactional throughput as well.

So, that's part of the equation that we look at as part of this.

Got it.

Then, generally around security, it seems when I look at your competitors, Cisco and Juniper, their security market share seems to have stabilized.

Is it getting incrementally harder for F5 to gain share in security, or are you now -- and are you are now seeing a different class of competitors?

Mark, this is Manny, let me take that.

In general, no, it's not getting incrementally harder.

Obviously, the competition is aggressive and as we enter the market they are going to continue to target not only themselves, but also, us.

What we're seeing is we are seeing a new set of buying patterns that are developing, and there's three predominant use cases that we are positioning our solutions to -- and, this is the solutions that John talked about around our Application Delivery Firewall.

The three use cases are mobile and fixed operators, and that is really all about performance and massive expansion in throughput, connections per second, things of that nature which our platforms are well suited to accommodate.

The second is really what I would refer to as the enterprise and service provider, IT, or Internet data center, this is the protection of your [www] applications and being able to defend those from DDoS attacks all the way to application vulnerabilities.

The third thing we are seeing, which is really why we have expanded so aggressively with our virtual additions, is being able to protect applications as you send out to the cloud -- meaning, the hybrid environment, if you will.

In those three use cases, we feel very comfortable with our solution sets.

We are well positioned, great performance, great scalability, and we bring unique value, so we think we are in a prime position to continue to grow there in the market.

That's helpful.

Jayson Noland, Robert W Baird.

Just to step back, John, a question on your comment about challenging macro.

Is that a reference to Federal and Japan, or were you seeing smaller deal sizes or delayed deals in US enterprise and Europe?

It was more of a reference to Federal and Japan because we did see improvement in the other regions, especially North America, actually.

However, we should say that -- in previous calls, we have talked about the $1 million-plus deals being less than we have previously seen.

We still saw that trend last quarter.

In fact, to be more specific, we actually saw $500,000 to $1 million deals up quite significantly, but the $1 million-plus ones down to similar levels to Q4 and Q3.

So, we are not dismissing that macro because we definitely believe that is a macro scenario, where instead of spending $1.5 million, you spend $900,000.

It really was quite significant.

So, some of the upside was pushed out into this year, possibly?

Possibly.

That's an interesting question because we are seeing the pipeline -- and this is obviously linked to be forecast, but we are seeing the pipeline of $1 million deals increasing, so that is a good sign, and we will see what happens.

At the end of the day, we will measure it next quarter.

Okay.

Last question for me on the Cisco ACE replacement opportunity.

What's a sense of urgency out there?

Are people in a hurry here, or are they just kind of sitting back waiting to see what Cisco is going to do?

I think it's pretty reasonable.

I can't remember the last time we have won three Fortune 50 projects, brand-new projects in a while.

I also think there is no doubt it is linked to our new business being up more than it normally is.

It was 46%; it is usually right about the 40%.

When we did the North American -- the Americas, I should say, [QBR] at the beginning of this week, and there was a lot of discussion from all of the management team about ACE opportunities.

I know we are hearing the same.

And from a customer's perspective, I guess it depends on what the application is running.

If it is mission critical, I think if I was them, I would be -- I'd have some urgency.

Thanks, John.

Alex Kurtz, Sterne Agee.

Andy, can you take us through gross margin in a the little more detail this quarter?

It looked like, obviously, very strong product margins, but if I look at your guidance it implies it being down sequentially.

Can you just take us through that a bit?

Yes.

The key driver that led us to really what is now an all-time high for us on product margin was a very strong quarter in software sales.

So, not only software modules, but sales of our virtual edition.

We see that as good.

Part of the guidance -- I look at the guidance as more flattish.

We do think we will see some pullback on the service side a little bit as we continue to hire there.

Obviously, customer satisfaction is of utmost important to us, and we want to keep hiring in that area.

I see it as flattish is how I would characterize it.

Okay.

John, on US Federal, post the close of the quarter, have any of those deals, or some of the pipeline that was getting stuck at the end of the quarter, are you seeing any improvement, or is it the challenge is continuing here?

I normally wouldn't comment on that.

We are asked that type of thing a lot.

It is not something -- yes, there's no big trend there that you should think about.

We are still being conservative on the Federal because it really was down -- especially sales bookings were down quite substantially last quarter from the budget flush that happened in September.

Thanks, guys.

Rod Hall, JPMorgan.

I want to paraphrase what you've said so far, and then I had one more question.

I want to make sure this is accurate.

It sounds like you experienced federal weakness in the quarter just reported.

The quarter you're guiding the slight revenue weakness that you're guiding for, is that continuing federal, underlying federal caution?

Or, are you adding to that with some enterprise weakness?

I guess there's a little bit of a question buried in that.

Then, as you look to this recovery late in the year, can you talk to us about what the main driver there is?

It sounds like you think maybe the telecom business is the primary driver for that growth recovery?

And, if you could quantify where you get to on growth rate as well?

Do you get back to a mid-teens type of growth rate by the end of the year?

Any help you can give us there would be good.

Apologies for starting off negative, but on the final bit, we're not going to give the growth year.

We are going to take that a quarter at a time.

We do think, as Andy said, we believe that in the second half, product revenue growth will accelerate, but that's the best we're seeing there, Rod.

On the forecast, we are being cautious in Japan and Federal.

I think we have to be there.

In terms of the Telco as being the most exciting -- it's certainly up there.

It is very exciting.

Manny talked about the wide range of portfolio in there that we can sell into these telcos that are pretty unique in a whole lot of areas.

The ACE opportunity is massive for us.

We think the product refresh, if it follows any historical trends whatsoever, will be significant as well.

And then, the rest of the Solar, with the hypervisor -- so, there is a bunch of stuff.

Most of which, by the way, helps Telco but also helps the other verticals in the enterprise.

John, it kind of sounds like you guys are -- regardless of what happens in the macro, you are positioned to grow in the second half of the year is the way you feel?

Is that the right way to think about it?

From a product revenue growth acceleration perspective?

Right.

Yes, that's correct.

That's how we feel.

One last little thing is on SDN, you made some comments about how you are positioned well to be integrated in SDN.

It does feel like, though, strategically you are moving to providing layer-four through seven services a wider array of them.

But if you are not in controller market, you potentially are at a strategic disadvantage, and I just wonder -- you guys are pretty good at software, would you ever consider moving into that controller market?

Our -- this is Karl, by the way.

With SDN, the BIG-IP platform is inherently designed to enable SDN environments.

And, we are not trying to move into the switching business with that.

What that means for us is that we work with an ecosystem of partners that allows them -- or allows our customers to implement these broad SDN-enabled applications and networks.

We are partnered with -- we talked about at VMworld, we demonstrated with VMware the service orchestration solution for vCloud.

We have open-flow partnerships.

There was a press release that went out with, I think it was Big Switch that released a press release that talked about our interoperability with them.

Our platform is designed to work with these different applications -- these different control protocols and provide that application knowledge and really help optimize managed secure do whatever, but focused on the applications as well.

Great, okay.

Thanks a lot, guys.

Simon Leopold, Raymond James.

I wanted to follow-up on a couple things that were touched on earlier.

One is in terms of -- I would like to get a better understanding of the Telco vertical-use cases.

And, let me share my understanding of how they have been used is largely in the telco data centers historically, and not really in the network, and I think you have talked a lot in the past about opportunities and applications in the network.

Could we get, really, a better understanding of the timeline of your expectations of, let's say, greater network participation in the telco vertical?

Yes, so obviously -- this is Manny, Simon.

Obviously, the data center space is something that you mentioned you are familiar with, so I won't go into that.

But obviously, there's a litany of solutions inside the data center space that we provide.

In the core network where our primary use case is is really in the packet core, getting inside the packet core, analyzing the traffic flow, and being able to understand the application of subscriber traffic flow.

And based on that, be able to apply a set of network services to monetize, if you will, or to optimize that.

Let me give you an example of that.

A typical example of that would be to understand who the subscriber is, what application they're trying to access.

If that application tends to be a video application, we may resteer that traffic to a caching engine.

Or, if it's a non-premium customer, we may rate limit that traffic so that they don't consume all of the RAM bandwidth.

At the same time, depending on what the flows are, we may want to provide security services or carrier-grade NAT services.

So, what we're doing is, by understanding of the application of the subscriber, we are able to implement a set of services inside that infrastructure, consolidating that, reducing the cost of the operator, at the same time, giving them monetization strategies.

In addition to that, we are moving very aggressively into the LTE space, and we're looking at the growth in 4G networks and how 4G networks also integrate with 3G networks and roaming across 4G networks.

As a result of that, our Traffix acquisition that happened, now, approximately one year ago, is something we are aggressively pursuing with all of the mobile operators as we move out there.

That footprint is also active, very active right now, and we have seen some material wins over the last couple of quarters, so we are continuing to engage in that.

Those are two predominate use cases above and beyond the traditional, if you will, data center solutions that we offer.

Have any of the use cases that you just described contributed to revenue yet?

Or, are they still on the come?

No, they are -- they are attributing to revenue.

As a matter of fact, a lot of the new modules we have introduced over the course -- or we are introducing here in the next couple of weeks, were being implemented in our platforms through iRules, right, because we have an open data plane and we allow our customers to program to that.

So, the net of it is that we have been monetizing this through the classic platform for numerous years.

Now, what we're doing is we are exposing that through our GUIs, making it easier for other operators to manage this environment, which is really what they're looking for.

They're looking for visibility and exposure and monitoring capabilities to be exposed natively in the product, without it having to be programmed, if you will.

Great, that's helpful.

The second thing I wanted to ask about was you talked about wins from displacement of ACE products.

Just wondering two aspects of that -- one is if you could characterize your win rate, given that your competitors are also trying to exploit the same opportunity in displaced ACE; and second part of that is, have you had to sacrifice any margin or pricing as incentives for those trade-ins, whether there was any kind of trade-off for those wins?

Thank you.

Dave might want to comment on this as well, but we -- as I say, I mentioned earlier, we sat through the North America -- I keep saying that -- the Americas, I don't want to forget Canada and Latin America.

The Americas QBR on Monday, and we heard about the wins, and I didn't hear any losses.

Now, you are going to not win deals you don't see, that happens.

But, the win rate seems to be incredibly high.

No, we are doing very well on the win rate, and we certainly have given incentives to our partners, and certainly, trade-ins to the customers on -- to give -- bring the business in quicker and sooner.

We are not seeing any real losses to our competitors in the Cisco ACE at this time.

If I may add something -- this is Manny, again.

We are not only seeing direct replacement, if you will, for server-load balancing around ACE, but we are also seeing a very rapidly evolving landscape around threats and vulnerabilities that are out there.

Some of these decisions our customers are making are not just to replace the ACE functionality, but they are to bring new functionality into that environment, like IPv6, like protection for DDoS, things that we natively do, also, in our platform.

So, it is not just an apples-for-apples replacement, they are really up leveling their infrastructure and positioning for the future.

Great.

Angie, this is John Eldridge.

We are going to take two more questions and then wrap it up.

Kent Schofield, Goldman Sachs.

To follow up on a couple of questions around software, you mentioned adding some performance features to the virtual additions.

Can you talk a little bit about what those are and what those mean for your software business going forward?

And then, as a follow on as well to an earlier one, you mentioned some alternative approaches in the tech space.

How does that software play of yours fit into, hopefully, addressing those alternative approaches?

Kent, this is Karl.

With the VEs, we significantly enhanced performance, so now we have three-gigabit versions pretty much straight across all the different hypervisor types, where they can allow that.

So, that enabled customers, now, in their virtual environments to run us three times faster than previously.

And then with regards to -- you were referring to these customers that I presume to Dan's comments earlier about some of these environments where they have changed their architecture.

In those environments, what they have done is they've gone and started leveraging some newer technology around JavaScript and some technology called node.

And, what they are doing there is, essentially with their own development teams, kind of writing their applications to inherently understand they are to be a part of that framework.

With our newer -- some of the newer functionality coming out in the BIG-IP -- and this is just a sampling of it, we have some new APIs, these REST-based APIs, both with our new BIG-IQ management platform, also we have next-generation version of iControl that's a part of the BIG-IP product itself, that allows it to inherently adapt better to these different JavaScript, or these node, or these other type of web-based environments, more easily than in the past.

So, they can automate, manage, orchestrate their applications much easier there.

And, there's a lot more behind that in terms of our road map of what we're putting down with that.

We have some new stuff for the cloud-based orchestration and et cetera.

We think we have a significant offering coming that, again, helps us in those environments.

Great, thank you for the detail there.

Tal Liani, Merrill Lynch.

Just a quick question on the risk in launching the products.

When Cisco launched, or refreshed their switches, all of their switches at the same time, they have seen some kind of validation.

People bought the upgraded low end instead of buying the high end.

I have seen the same phenomena with similar companies, similar launches.

What is the risk that you see -- or what are you doing to mitigate the risk that when you launch so many new products together, people downgrade to a lower product that's upgraded?

Remember, we have done this before, Tal.

Obviously, I don't want to sound complacent about the risk because you always have to look at that type of thing.

However, our platform is fairly unique in its ability to add more and more services, typically, through software modules.

And, we have seen from the field a clamor for the ability to do more software modules at the entry level, more capability with vCMP with Virtual Clustered Multiprocessing where we can build more and more added value to the platforms.

And, that tends to be way far and above the cannibalization effect that may occur.

We feel pretty confident -- when we look at the 4200 sales we have had, we feel pretty confident that that's the way it will go.

There's much more upside than there is downside in terms of cannibalization.

Okay, thank you.

Thank you very much for joining us, and we look forward to talking with you all again a couple of months from now.

Thank you.

That does conclude today's conference.

Thank you for your participation.

You may now disconnect from the audio portion.