F5 Inc (FFIV) 2013 Q3 法說會逐字稿

Good afternoon, and welcome to the F5 Networks' third-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 call is being 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.

Thanks, Sharon.

Welcome, everyone, to our conference call for the third quarter of fiscal 2013.

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

Other members of the 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, it's available on our website at 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In addition, you can access an archived version of today's live webcast in the Investor Relations Events Calendar page of our website through October 23.

From 4.30 p.m.

today until midnight Pacific time July 25, you can also listen to a telephone replay at 888-568-0863 or 203-369-3930.

During today's call, our discussion will contain forward-looking statements, which 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.

Results for the third quarter of fiscal 2013 came in above our expectations.

Revenue for the quarter was $370.3 million, up 6% sequentially and 5% year-over-year, and above our guided range of $355 million to $365 million.

GAAP EPS was $0.86 per share, above our guidance of $0.80 to $0.83 per share.

Non-GAAP EPS was $1.12 per share, also above our guidance of $1.06 to $1.09 per share.

For the third quarter of fiscal 2013, product revenue of $196.7 million represented 53% of total revenue, up 6% sequentially and down 5% from Q3 last year.

Service revenue of $173.6 million grew 5% from the prior quarter, and 19% year-over-year, and accounted for 47% of revenue.

Book to bill for the quarter was greater than 1.

Revenue from our Application Delivery Networking business was $366.8 million, and revenue from our ARX File Virtualization business was $3.5 million.

By region, the Americas represented 58% of total revenue, up 6% versus Q3 2012.

EMEA contributed 21%, a 4% increase year-over-year.

APAC accounted for 15% of revenue, up 7% from a year ago.

And Japan was 6% of revenue, down 7% from Q3 2012.

During Q3, the financial vertical accounted for 22% of total sales; telco was 21%; technology, 16%; US federal government was 4% of sales, with total government accounting for 13%.

Three of our distributors each contributed more than 10% of revenue in Q3.

Ingram Micro accounted for 15.6%; Avnet accounted for 13.9%; and Westcon accounted for 11.2%.

GAAP gross margin in Q3 was 82.5%.

Our non-GAAP gross margin was 83.5%.

GAAP operating expenses of $201.3 million were within our guided range.

Non-GAAP operating expenses were $176.3 million, also within our guided range.

Our GAAP operating margin in Q3 was 28.1%.

Non-GAAP operating margin was 35.9%.

Our GAAP effective tax rate for the quarter was 36.3%, and our non-GAAP effective tax rate was 34.9%.

On the balance sheet, cash flow from operations in Q3 was $126.2 million, and we ended the quarter with $1.27 billion in cash and investments.

DSO at the end of Q3 was 50 days.

Inventories at quarter-end were $18.3 million.

Deferred revenue grew to $519.8 million, up 20% from a year ago.

We repurchased approximately 633,000 shares of our common stock in Q3 at an average price of $78.90 per share for a total of $50 million.

Total headcount at quarter-end was approximately 3185 employees, a net increase of 30 from the prior quarter.

Now for our Q4 outlook.

During the third quarter, revenue and earnings exceeded our guidance and our internal expectations despite continuing softness in the global economy.

While we aren't assuming a material improvement in the macro environment in the near-term, we believe there are a number of drivers specific to our business that will enable us to grow.

With this in mind, we have set a revenue target in the range of $378 million to $388 million.

We expect GAAP gross margin in the 83% range, including approximately $2.5 million of stock-based compensation expense, and $1 million in amortization of purchased intangible assets.

During Q4, GAAP operating expenses are expected to be in the range of $199 million to $206 million.

This includes approximately $19.5 million of stock-based compensation expense.

I want to call out that our Q4 anticipated stock-based comp expense is considerably lower than both our Q3 expense and lower than our expected run rate going forward.

To better align our annual review process for employees and our annual award date for RSU grants, we have chosen to move the award date from August 1 to November 1. This results in this lower expense in Q4 and a higher expense for Q1.

We will give guidance for Q1 on our next call as usual.

Also included in our GAAP operating expense target is an expected one-time $2.5 million charge related to the extension of certain subleases at our corporate headquarters.

As this charge is non-recurring in nature, it will also be excluded from our Q4 non-GAAP results.

We are forecasting a GAAP effective tax rate of 37% and we expect a non-GAAP effective tax rate of 35%.

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

Our non-GAAP EPS target is $1.17 to $1.20 per diluted share.

We plan to increase our headcount by over 150 net adds during the quarter.

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

We expect inventory levels within a range of $18 million to $20 million, and we expect cash flow from operations in excess of $130 million.

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

Thanks, Andy, and good afternoon, everyone.

I was very pleased with our Q3 performance.

In particular, we delivered solid sequential growth of 6% over Q2, with even higher sequential growth in overall sales bookings.

The star of the quarter was the Americas region, which had very strong results, exceeding our internal forecast.

In our previous quarterly call, we mentioned that the slowdown in orders we experienced late in the second quarter was most pronounced in the Americas region.

I was especially pleased our business in the America's bounced back very quickly in Q3.

Our Asia-Pacific region achieved its internal forecast, and our EMEA region missed its internal forecast, but not be a significant amount.

Our services business had another stellar quarter, exceeding revenue targets as well as posting a solid increase in deferred revenue.

We saw a number of very encouraging trends in the quarter.

Sales of the new products we have been introducing over the last two quarters continue to be very strong.

In particular, we saw solid orders for the new entry-level BIG-IP 2000 Series platforms, which we introduced in Q2.

This trend was similar to the strong traction we saw with the BIG-IP 4000 Series when it was introduced in Q1, and we continue to see this sales momentum accelerate through Q2 and Q3.

These results bode well for our newest BIG-IP platforms, the midrange BIG-IP 5000 and 7000 Series.

Both these products were released at the end of Q3, and they're available for shipping in the current quarter.

We also announced a number of exciting new solutions last quarter in our latest TMOS release called Corona.

These solutions make it easier for organizations to scale to the cloud, extend software defined networking deployment, and add intelligence and program availability via iCall to IT environments.

With our unified suite of physical and virtual products featuring F5's innovative scale end, multi-tenant and clustering architecture, organizations can seamlessly scale operations to realize the full value of virtualization, cloud computing and on-demand IT.

With our newly released iCall technology, F5 is setting the standard for increased programmability and control plane extensibility, providing the dynamic automation of event-driven policy decisions in the network.

We also continue to build momentum in sales of our software virtualization products.

We have by far the largest portfolio of virtual software solutions in the market today.

Now with the TMOS Corona release, we have the industry's only virtual ADC solution that supports all of the top five hypervisor platforms, with up to 5 gigabits per second throughput.

We plan to increase our performance leadership with these software solutions, and our goal is to deliver by early next year versions that will support greater than 10 gig.

The combination of our industry-leading portfolio of virtualization products and our hardware-based solutions represents the broadest and most fully featured array of ADC solutions in the market.

We are pleased with the growing awareness of our security solutions in the market.

We experienced a record quarter for all major security solutions, including our Advanced Firewall Manager, Access Policy Manager, and Application Security Manager.

Additionally, we are expanding our relevance in the service provider market with these security solutions.

During the quarter, we extended our security solutions to service providers by delivering the Gi Firewall as part of our application delivery firewall.

F5's new offering is situated on the perimeter between the service provider's mobile network and the Internet, which is ideal for protecting both subscribers and network from targeted attacks such as DDoS threats from a variety of sources.

F5's application delivery firewall delivers scalability and throughput characteristics far beyond traditional firewall architectures, and is now a key strategic solution in our growing intelligent application services framework portfolio.

Network World just published an independent review of our advanced file manager, which validated F5's consolidated approach to security, and demonstrated the performance and scalability advantage that can be achieved with our ADC architecture.

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

As I mentioned earlier, I am very pleased with the improvement in our sales last quarter, though clearly, we need to remain cautious given the current spending environment.

However, I feel very optimistic about the future prospects for F5.

Among the drivers of our business going forward, we continue to gain momentum in our initiatives to replace Cisco's installed base of ACE products.

As I have mentioned in the past, we are seeing a clear pattern where we replace ACE products with F5 platforms, offering customers additional functionality, including security, access control, and application acceleration.

We are experiencing a very high win rate with this approach, and expect to see the continued growth of these opportunities in our pipeline.

In addition, there are a number of trends happening in the technology landscape that I believe F5 is uniquely positioned to take advantage of, including the growth of private and public clouds, mobility, complex global security threats, network function virtualization, and software defined everything.

We now -- we have now rolled out a complete new range of BIG-IP appliances, which increase our technology leadership and competitive position in the ADC market.

In addition, our product roadmap includes some significant enhancements to our VIPRION platforms, including a second-generation blade for the popular VIPRION 2400.

This new VIPRION 2250 blade will significantly increase the VCMP multi-tenant density by a factor of 5. We will also be offering a version of the current generation Victoria blade that doubles the VCMP density.

Both blades will significantly improve the performance of our software modules when running with VCMP.

We have enjoyed great success in increasing the addressable market for our solution portfolio, especially in the security and service provider markets, with products like our Advanced Firewall Manager and the BIG-IP Carrier-Grade NAT, and policy enforcement modules.

And we will continue to expand and enhance the functionality of all these modules.

We also have a strong and growing pipeline of traffic -- of opportunities for our traffic diameter solutions for LTE rollouts.

Our traffic's offering won the Most Prestigious in Form Award at the LTE World Summit last month, beating all our major competitors.

We continue to help our customers address their growing mobility challenges with the industry's only consolidated solutions that accelerate application access across the client, network and data center.

This is critical to delivering a superior end-user experience and on-demand content to any mobile device.

During the quarter, we announced a BIG-IP application acceleration manager to enable our customers to accelerate applications wherever they reside -- in the data center, or in the cloud, and wherever they are delivered -- on premise or to mobile devices.

We also introduced a new centralized management platform, BIG-IQ.

The initial release of BIG-IQ included our cloud manager for data center to cloud automation, and security manager to provide centralized support for our advanced firewall ACL programming.

Our strategy is to have BIG-IQ provide centralized management orchestration and automation for all big IP modules, either as standalone software solution and/or as integrated systems.

I'm convinced that F5 has the unique experience product application services, ecosystem and vision to drive the new emerging applications and network architectures.

I'd like to take this opportunity to thank the entire F5 team and our partners, and look forward to the continued support throughout the year.

We will now hand the call over for Q&A.

(Operator Instructions).

Jess Lubert, Wells Fargo.

Thanks for taking my question.

A couple questions here.

First, can you quantify how much of the business that slipped last quarter, closed this quarter?

And then, perhaps, from a broader point of view, can you talk a little bit about what you're hearing from both your enterprise and carrier customers, with respect to their willingness to move forward with some of the larger million-dollar deals, where you had previously seen some weakness?

Yes, in terms -- it's hard to really quantify in terms of percentage or actual numbers, but there is no doubt that we -- I think I said in last quarter's call, Jess, that we had a strong start to the quarter.

And I'm sure some of that was linked to some of this slippage in Q2, which obviously was pretty pronounced -- I especially referred to some telco wins at the beginning of the quarter.

Having said that, we saw that strength continue throughout the quarter, and the following two months were also very strong.

So it's not like we saw a strong start slowing down; we didn't see that.

We saw the opposite.

There's no doubt that enterprise spending in particular in North America, I should say in particular, definitely picked up from Q2, and obviously, telco did as well worldwide.

And then, John, if I look at your federal business, it seemed like that remained a little bit challenged in the period.

Can you talk a little bit about how you're thinking about federal here, and to what extent you are expecting some typical fiscal year-end behavior from the federal government?

Yes -- no, absolutely.

And there's no question that with what is going on in federal it's well-publicized that you do need to be cautious.

And the first three quarters of this year, we have seen bookings actually down year-over-year, not significantly, but down.

Moving into the final quarter, having said that, we absolutely expect to see sequential growth, but I think we've taken a fairly cautious approach in terms of using -- taking that into account in our guidance.

And last question for me, but product growth appeared to perform much better in the quarter.

And with most of the new products now in the market, I guess the question is, at the high end of your guidance, would you expect your product growth to be positive in Q4?

Or do you think this may take another quarter?

We're not going to take a specific answer to that.

It's clearly by a mile our number one priority.

I think we have a lot of good opportunities to get the product growth accelerating here with the product refresh, which is a big deal and is now completely out there in the market; the ACE opportunity; security; LTE rollout.

So, clearly, that's our main focus.

And, John, before I let you go, I didn't hear the answer on the million-dollar deals.

Did you see any improvement?

(multiple speakers) I didn't answer it, which is why.

We saw a pretty similar -- the million-dollar deal is pretty similar to the previous quarter.

I mean if there is any good news in this, it's that the comparisons now are effectively okay.

But we did see it pretty similar to the previous quarters that we have seen.

We did see, but, from accounts, in general, an uptick in sales.

So maybe not all million-dollar deals, but from some of our larger accounts, we saw them start [participating] more.

Thanks, guys.

Ben Reitzes, Barclays.

I wanted to talk to about the guidance.

Did you hold back at all in your guidance for maybe some of the deals that slipped into -- you know, in terms of the sequential growth rate?

Or do you feel like you're being conservative with regard to the sequential growth rate you guided for on the top line?

And what I mean is, if some stuff was pushed into the quarter from the last quarter, did you hold back on your guidance and all?

And how can we gauge your conservatism, given the environment?

(laughter) I mean we took -- I believe we have taken a reasonably conservative approach in terms of the -- one of the key factors we are looking at is the close rate.

And from a close rate perspective, we have taken a mix of the previous two quarters.

That includes, obviously, the tough quarter of Q2.

So I think it's been reasonably conservative.

But I think that's absolutely appropriate to be cautious, given what we saw in Q2.

And how did you feel about the competitive environment as we went throughout the quarter?

If I looked right, the Citrix numbers looked pretty strong in networking.

And did you notice anything different?

Did it ease?

And are you still not really seeing them, other than in -- other than the desktop virtualization market, et cetera?

Was there anything there?

No -- it's a really good question.

We -- well, first of all, we are definitely seeing strength of the new products we are introducing.

And I'm absolutely convinced we will see strength for the 5000 and 7000 that are now available as well.

So we are seeing strength there.

And I think that momentum will continue.

Because that product refresh we did wasn't just a simple box refresh.

That's all about we introduced architecture.

We introduced new modules.

We introduced VLAN architecture.

We introduced VCMP.

And so this is a big product refresh, I think is going to help our competitive advantage.

But to be specific, absolutely by my old Citrix is a one competitor, but we look -- we did a lengthy quarterly business review with our North American sales management on Monday.

We had them all here in Seattle.

The competitive win rate is as strong as it has ever been.

It's very, very strong, as I mentioned, in the ACE replacement space.

Our security business is strong.

I think our competitive position is great.

On the VDI side, we just -- where we get a chance, we have a good win rate.

But clearly, especially with Citrix only VDI solutions, I'm sure there's a lot of deals we just don't see there.

All right.

Thanks a lot.

I appreciate it.

Sanjiv Wadhwani, Stifel.

Just a couple questions.

John, last quarter, I think with the AFM modules, I think they were out for just one month.

You had mentioned 50 deals in the last month of the quarter.

Any updates on that metric as far as the AFM modules are concerned?

And then on the virtual appliances, you obviously spent some time talking about that.

But just broadly, how should we sort of think about as it relates to your ADC sales going forward, as we see the shift happening on the virtual side?

It will probably take some time, but just trying to get a gauge as how we should be thinking about your broader ADC sales within that context.

Thanks.

Hey, San.

This is Manny.

Just thought I'd answer both questions here.

So, first of all, on the AFM module, we saw -- as you know, we announced the module last quarter, and it was out in the market for approximately four to six weeks.

We saw huge growth on that module this quarter.

We're very, very pleased with the momentum it's picking up inside the market.

And we continue to see across all verticals and across all theaters, good traction on that module.

So we're excited.

It's early, but progress has been phenomenal so far.

And that's both in enterprise and service provider use cases, so we're pretty well-rounded there.

And then, real quick, on the virtuals, just to give you some insight -- you're absolutely correct.

I mean, there is a lot of talk in the industry about it all moving to potentially virtual solutions.

What we are seeing from the customer base is that, really, it's a hybrid solution set.

There is a need for virtual solutions, and there is a need for physical hardware solutions.

And that has to do really with placing the network and the architecture you are looking to deploy.

What we have been doing on the virtual solution side is that we've been increasing our performance capability, as John pointed out, and we have solutions from 200 meg all the way up to 5 gig, highest throughput in the industry, across all of our modules, across all of the industry hypervisors.

And as we look forward in the coming quarters, you will continue to see us improve on that performance, both going upstream, higher throughput, and downstream to lower throughput.

So our intent is to have all of our modules across all physical as well as all virtual appliances in the industry, giving you the flexibility from an architectural point of view.

And we're actually seeing that also in the IDC most recent data that was just published in Q1, where we saw great, great traction also there from a market share perspective.

Got it, that's helpful.

And just one quick follow-up on the AFM stuff.

Any metrics that you care to share, like last quarter, I know it was out for only four to six weeks.

But any metrics that you might be able to share?

This is John again.

I'll take the negative side of it.

(laughter) No, we are not going to be specific on that.

And we haven't been in any other module.

We gave some numbers in the very first quarter release of the product, but the growth was quite significant.

Still a small percentage of our business, but we'd expect it to continue to grow.

Got it.

Thanks.

George Notter, Jefferies.

I just wanted to expand on the question around the virtual solutions.

So, can you help us understand how the economics work for F5?

If you look at an analogous product, hardware vis-a-vis software, what's the delta in terms of ASPs?

What's the delta in terms of gross profit dollars?

I mean anything you could kind of help us with there, that would be great.

So you're asking just on a deal structure what it could mean revenue-wise and margin-wise, comparatively, with hardware?

Yes, and that's exactly right.

So if I trade a hardware appliance sale for a virtual sale, how does that economic impact play out through your numbers?

So what we have seen so far, and this speaks to what Manny was saying, is that when we do sell software vADCs, a lot of times the revenue difference is made up in multiple versions of the software version.

So we haven't seen a big difference.

We have seen stronger gross margin, because a big component of that is software.

But at least to date as we have looked at it, it's been fairly neutral.

And we have seen a lot of hybrid sales as well, where you've got a combination of systems and software-only solutions.

And remember, we keep pressing this point because it's a big differentiator, is that we can basically manage the software and systems identically, and integrated and/or standalone.

And that's pretty flexible for the customer.

But there's no one-for-one on this.

It's a combination of architecture approaches.

In terms of, is there going to be a long-term trend?

Maybe.

But wow, it will be very, very long-term in nature.

And let me just add, this is Manny, one more comment just to add here.

I alluded to the architecture trade-offs.

Usually when you see a hardware sale, what you are quite often seeing is a consolidation inside that device of multiple applications, or services sitting behind that device.

And sometimes when you see virtuals, what you are seeing is virtual per application.

So it is more of a scale-out horizontal scale.

So to the point of, is there a revenue shift or -- obviously, Andy talked to the margin -- but is there a revenue shift?

No, it's just a different architecture, where you have less consolidation.

You have more single tenancy with the virtualized addition provided for that application.

Got it, great.

Thanks very much.

Troy Jensen, Piper Jaffray.

Hey, congratulations on the nice quarter, gentlemen.

A quick question for Andy here.

So gross margins down slightly here.

I don't want to nitpick here, but historically, you guys have been able to expand your margins with revenue growth.

So I'm just curious if you can explain why we have seen a downtick in gross margins the past two quarters?

And is it pricing (multiple speakers) or is it mix?

(multiple speakers) And actually if you go back to Q1, we were really at an all-time high.

And that was driven by software and we talked about that then.

But you're right -- over the last two quarters, what we have seen as we have brought out these new platforms, getting our [depots] stocked, just the product transition, we have seen what we believe are short-term increasing costs around that.

And we see that reflected in the gross margin results.

As you heard from our guidance, we expect that to come back in this coming quarter a bit.

Okay, fair.

(multiple speakers).

Andy, how (multiple speakers) --

And just the other point, it's not quite directed to the question, but obviously, you saw our operating margins increase this quarter, driven by revenue.

And we will give more data about that in October, in terms of how we see it for the year moving forward.

But I am just going to take this opportunity, when you're looking at the year coming, that we will see seasonality in the December quarter.

We have seen it before.

I just want to put that stake in the ground while the discussion in margin reminds me to.

Yes, okay, perfect.

And how about, Andy, just one more here on service revenues -- historically, that's grown 30% year-over-year, very healthy clip.

Now it's sub-20%.

So I'm just curious what your thoughts are for services growth going forward?

Yes, you know, that's going to go back to John's comment that our number one priority is product revenue growth.

And so I think what we have seen over time is that service revenue growth is going to slow if our product growth doesn't take off again.

So they are linked; it's just over a more elongated period.

So I'm hoping we are going to start to see that shallowing out.

And we will talk more next -- on the next call about what we think next year will look like.

But definitely tied to product revenue growth.

That's got to be the priority.

Yes, understood.

All right, guys.

Keep up the good work.

Paul Silverstein, Cowen.

John and Andy, I trust by virtue of your guidance that the answer is self-evident, but last quarter, you commented about the start of the new quarter, so similar question to you now, in terms of the start of your fiscal fourth quarter.

Again, I trust for the guidance that it's been a strong start.

And then I've got one or two other quick questions.

Yes, I knew I would get asked this.

And the only reason I get -- we never normally give an update on the month certainly at the day of the call.

We had a pretty big miss in Q2 and that's why we decided to do it.

And so I'm not going to do that.

Having said that, absolutely, we take into account the first three weeks, and more importantly, the quarterly reviews that we have when we give our guidance.

So that is baked into that, yes.

John, I understand, and I suspected that was the case, but I still wanted to ask.

A couple of other quick items.

One, I know it's very early, but the carriers made a lot of noise about they were (technical difficulty) this virtualization.

I know you addressed it in your prepared remarks.

But is there any insight you can share with us at this point as to how you play in an NFV world?

And, also, I know it's still small, but you mentioned it's growing -- is virtual anywhere close to 5% to 10% of total revenue at this point?

Is that something you care to comment on?

Yes, we're not going to be specific.

It's a small number still, virtual.

When we've talked virtual, we're talking about -- we are not talking about our total modules, software modules, which obviously is added onto that.

But the virtual number still is reasonably small, although we have seen some fairly big deals happening.

And it is linked to the architecture.

In November, at the Analyst Day --- and we will talk about it again in October -- we're going to go through this in a lot of detail.

I think people will be impressed at where we are, in terms of what we think our strengths are in this type of environment, and what our roadmap looks like, and what our product portfolio competitiveness is like.

So we will talk more about that as we move forward.

But Manny, do you want to just comment right now?

Yes, I can comment on Network Function Virtualization.

I mean, we are well-positioned.

We -- because, as we pointed out before, we support all of our modules across all major hypervisors.

And Network Function Virtualization is really just what the service provider is looking at moving from hardware devices into virtual devices, meaning devices sitting on hypervisors on our COS platform.

So we have been taking our solutions into the marketplace.

We are working with various service providers.

We're part of the ETSI standard and working in that working group to make sure that they continue to shape that.

So it's early days, but you will see that beginning to develop in the service provider arena, because they themselves like, in data centers, want to take advantage of software where applicable.

So we think we are well-positioned, and that will shape up in the next 18 months, I think, industrywide.

And, meanwhile, in between, when we talk to service providers about our strategy of consolidation, where we talk about being able to do policy enforcement management, DPI, Carrier-Grade NAT, traffic steering -- a whole range of areas where they have separate boxes right now to do these functions, that we can do them within the same chassis or within the same appliance.

We love that strategy.

So I think Manny's 18 months is probably spot-on, but meanwhile, the consolidation approach we have is very attractive to them.

Thanks.

Last one for me.

Andy, average deal size?

Can you comment on that?

Yes, our average deal size has settled out really at about $100,000, and that's been consistent for the last three quarters.

Great.

Thanks, guys.

Erik Suppiger, JMP.

Yes, a couple of things.

First off, Japan seems to be slow still.

Can you discuss the competitive dynamics in Japan?

Yes, I think we have said this in the past, I mean, we're -- I think we actually gained market share in the -- I can't remember which quarter it was, but a recently published quarter -- which is obviously a reasonable sign.

But there is no question that A10 have done well there.

Obviously, with one particular very, very large telco that is an obvious one in particular.

They had some Carrier-Grade NAT capability that we have caught up with.

And we have got every intention of staying feature-rich there.

So I think moving forward, we're in good shape.

The biggest issue that we have seen in Japan, actually, is, we definitely saw an increase in business after the tsunami hit.

I think there's no question about that now, as data centers were built, et cetera.

And so when you look at the year-over-year, we have had a pretty tough comparison.

And that actually finishes moving forward next quarter.

So, yes, I think you will start to see a better year-over-year type result coming from that geography.

Okay.

And then on the hiring, it sounds like you have accelerated some of your hiring.

I think in the past, you have targeted about 100 additions and you have said 150.

Is that just an anomaly for a Q4?

Or are you getting more aggressive on the hiring front?

I think you're going to see us more aggressive with the way things are shaping up here.

I mean, frankly, if we can beat the 150 number, we will absolutely go for it and try and do that.

It's across the Company we're going to do that.

If things go the way we expect, what you will see is with fairly aggressive hiring numbers next year as well.

Is that biased towards sales, now that you have the new products?

Or where are those resources going?

Our product development is really critical.

We have got -- again, we will talk about this architecture that we have with our integrated architecture, our BIG-IQ, the areas we are doing there.

So product development is very high.

Service is always high for us because of customer satisfaction.

Consultancy is very big for us as well.

That has some margin implications, but that's life.

And it definitely drives product revenue.

And, of course, sales as well.

Very good.

Thank you and congratulations.

Scott Thompson, FBR.

Just wanted to ask a question about deferred revenues.

As you guys move into a virtual type platform, should we expect deferred revenues to start to ramp?

I noticed they were up a bit the last couple of quarters.

Let's talk about that.

And then, second question on service provider.

You made some comments about security starting to get some traction there.

Can you give us some more specifics?

Is that US-based or is it elsewhere?

Yes, so I will take the first part of the question on the deferred revenue.

Actually, we have very little product in our deferred revenue, at least now.

It's mainly annual maintenance contracts.

As we evolve our models going forward, we may change to something where we build up deferred revenue.

But as of now, we don't have anything of note in there.

Yes.

And then this is Manny.

Just a comment on the security and the service provider arena.

We are seeing traction in all theaters.

We're working with Tier 1 operators in all three theaters right now.

The general problem that they're struggling with is actually keeping up with the growing demand for bandwidth on the mobile networks -- specifically with the movement to 4G, and protecting everything from a DDoS all the way to an application vulnerability.

So we are well-suited for that.

As a matter of fact, I think you saw the article that might have come out earlier this week, from Network World, which talks a little bit about our performance.

And that was a midrange box -- not even the high-end of the market.

So we're working with these operators.

It's early, but it's quite often more than just security to the point that John made before.

While we are sitting in that footprint, they're not only looking at firewall capabilities, but they're looking at Carrier-Grade NAT capabilities, potentially policy enforcement capabilities.

So it's a whole new re-architecture that some of the providers are looking at.

And others are just looking at how to scale security needs.

Okay.

Thanks, guys.

Our next question comes from Subu (multiple speakers) --

(multiple speakers) I just wanted to interrupt and say we're going to take two more questions, and then we will call it a day.

Thank you.

Our next question comes from Subu Subrahmanyan of Juda Group.

Go ahead.

Your line is open.

I had two questions.

First, on the telco side, I was just looking back at last quarter, the lumpiness in the bounce-back.

Was it just, do you think, timing of deals?

Or is there any change in buyer behavior as they're kind of looking at new architectures?

And how do you expect that trend going to the next few quarters?

And my other question was on new product contribution for the new appliances.

How long do you think we'd see the ramp before customers convert over from your traditional appliances to the newer appliances?

Yes.

So on the service provider deals -- no, timing of deals, no major change there.

I mean, clearly, there was a number of companies talked about telco being slow in the first half.

And it seems to have definitely picked up, and that's what we saw.

So -- and it was global in nature as well.

So nothing -- no significant change there.

The only change we have seen in telco is, in terms of change, is we're definitely growing and growing pipe -- I mentioned this in my introduction, pipeline of LTE diameter opportunities.

That's definitely a positive change for us.

And then in terms of the -- I think I have the question correctly -- the new appliances that we brought out.

Yes, what we are seeing is that we introduced the product, and the first few quarter of shipments, we see a fairly strong momentum happening.

And we saw that with everything so far.

And we are hopefully going to see the same with the two new ones, the 5000 and the 7000.

So they have become our dominant product sale pretty quickly, actually.

If I could clarify, John, you made a comment on seasonality for December, was that in context of revenue or gross margin, that you made that (multiple speakers) --?

Well, that was in context of revenue specifically.

And, obviously, by definition, that affects operating margin.

Okay, got it.

Thank you.

Ehud Gelblum, Morgan Stanley.

This is actually Stan Kovler for Ehud.

Thanks for squeezing me in.

I just wanted to lead off with a question about the Fed.

It seems like that came back fairly nicely this quarter.

Is that something that we should expect to continue to improve going forward?

And I also just wanted to ask, in terms of the outlook, what you think going forward about the sequential growth next quarter -- do you think that the product revenue -- should we expect that to come back to the 2012 run rate on product revenue on a quarterly basis?

Does that sound right to you?

Yes, on the last question, we are not going to answer that.

I mean it's our number one priority, and we think we have got a whole lot of things in place that if we execute properly, we can make things happen.

But we're not going to be specific about timing, et cetera.

I think we have a lot of good growth drivers happen through a number of times here.

So on the Fed, our Fed business, actually, I think it was -- it was 4%, which is on the low side of our Fed business in the quarter.

So I don't know when you said bounce back quite well, I don't quite understand that.

As I did say in the previous question, we do expect it to be up sequentially, but I think we have been reasonably cautious, given the visibility.

Got it.

And just from a big picture standpoint, how did some of the new products fit into new business wins, cloud providers?

And what's going on with the tech vertical in general?

Are you getting some of that momentum back?

The question is how did our products fit into (multiple speakers) --?

The cloud providers.

-- the cloud providers?

Quite well.

As we mentioned before, we support all the virtual additions.

So if you are a cloud provider and you want to deploy your software in those environments, we do that today.

We work very well with Amazon.

We work very well with Rackspace and others that are out there.

So from that point of view, we are seeing good traction, good momentum, and are looking to continue to accelerate that this year.

So there is no issue whatsoever there.

Got it.

And on -- this is the last question -- on the headcount addition as a follow-up, is that regional based?

Or, on the product development side, that is mainly focused on just US and continuing to develop new products?

As a corollary to that, we saw that one of your biggest competitors made a pretty large security acquisition yesterday.

And so just curious how you feel about product development and security in general?

Is it something that you're going to continue to address internally?

Or do you feel like there might be some other technologies out there or other companies that may be of interest to you, to add into the portfolio?

Yes.

On the hiring, first of all, I mean it's global in nature, and especially when you look at the sales and service organization.

But we have a pretty global product development organization as well.

But the other three main priorities that we will be focusing on.

So, yes, probably in product development it will be more US-based, because that's where the majority of the people are, but, generally, it's a global approach that we have.

Regarding security, it's a -- we think security is probably our biggest growth driver.

I mean, product refresh is bread-and-butter and that's spread across everywhere.

But security is probably our biggest.

We have a very significant development focus on security.

We're always looking in the industry, that's what we have done for years and years.

And if we see something that we think can get to market faster than we can develop, we are not shy about making it happen.

But that's just business as usual, as far as we're concerned.

Okay, well, thank you all for joining us.

We look forward to seeing many of you out in the conference circuit over the next quarter.

And we look forward to catching up with you again on -- at the end of October.

Thank you.

This concludes today's conference.

Thank you for your participation.

You may now disconnect.