F5 Inc (FFIV) 2015 Q2 法說會逐字稿

Good afternoon, and welcome to the F5 Network second quarter 2015 financial results Conference Call.

(Operator Instructions)

Also, today's call is being recorded.

If anyone has objections, please disconnect at this time.

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

Sir, you may begin.

Thank you, Brian, and welcome to all of you to our Q2 2015 second quarter earnings call.

John McAdam, President and CEO, and Andy Reinland, Executive VP and Chief Financial Officer, will be the principal speakers on today's call.

Following John's comments on the quarter, Manny Rivelo, who will succeed John as President and CEO on July 1, will speak briefly about his goals, and the Company's strategic objectives going forward.

Other members of our exec team are also on hand to answer questions following these prepared remarks.

If you have any follow-up questions after the call, please direct them to me at 206-272-6571.

A copy of today's press releases are available on our website at F5.com.

In addition, you can access an archived version of today's live webcast from the events calendar page of our website through July 22.

From 4:30 PM today until midnight Pacific Time April 23, you can also listen to a telephone replay at 800-551-8152 or 203-369-3810.

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

These forward-looking statements involve uncertainties and risks 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.

Please note that F5 has no duty to update any information presented in this call.

Now I'll turn the call over to Andy Reinland.

Thank you, John.

Our second-quarter FY15 was marked by solid sales in North America, where we saw both a rebound in sales from large deals compared to our first fiscal quarter, and record sales levels in our service provider vertical.

These areas of strength were somewhat offset by some late-quarter softness in sales in our EMEA and APAC theaters, and Latin America region, likely impacted by the strengthening US dollar.

Revenue and earnings both grew sequentially in year-over-year, with several factors contributing to strong profitability and cash flow from operations.

Revenue of $472.1 million grew 2% from the prior quarter, and 12% year-over-year, and was above the mid-point of our $465 million to $475 million guided range.

GAAP EPS of $1.18 per share was above our guidance of $1.07 to $1.10 per share.

Non-GAAP EPS of $1.59 per share also exceeded our guided range of $1.48 to $1.51 per share.

The strength in EPS was driven by stronger-than-anticipated operating margin during the quarter, benefits to operating expenses, and other income related to foreign currency, and a more favorable tax rate than expected.

Product revenue of $244.1 million, up 1% sequentially and 8% year-over-year represented 52% of total revenue.

Service revenue of $228 million increased 3% sequentially, 17% year-over-year, and accounted for 48% of total revenue.

Revenue from the Americas accounted for 57% of total during the quarter.

EMEA contributed 24%, APAC 14%, and Japan 5%.

On a year-over-year basis, Americas and EMEA grew revenue 14%, APAC 11%, and Japan revenue was down 3%.

Enterprise customers represented 65% of total sales during the quarter.

Service providers accounted for 24%, and government sales were 12%, including 5% of total sales from US federal.

In Q2, we had four greater than10% distributors: Westcon, which accounted for 16.6%; Ingram Micro at 15.5%; Avnet representing 13.5%; and Arrow, which accounted for 10.5%.

Our GAAP gross margin in Q2 was 82.5%.

Our non-GAAP gross margin was 83.9%.

GAAP operating expenses were $256.7 million, at the low end of our guided range of $255 million to $264 million.

Non-GAAP operating expenses were $223.1 million.

GAAP operating margin was 28.1%.

Our non-GAAP operating margin was 36.6%.

Our GAAP effective tax rate for Q2 was 37%.

Our non-GAAP effective tax rate was 34.6%.

Turning to the balance sheet, cash flow from operations was $142.3 million, driven by higher than expected profitability, and stronger than expected collections in the current quarter.

In Q2, we re-purchased just under 1.4 million shares of our common stock at an average price of $113.29, for a total of $156.9 million, ending the quarter with approximately $1.13 billion in cash and investments.

Approximately $774 million remains authorized under the share repurchase program.

DSO at the end of Q2 was 50 days.

Inventories were $29.3 million.

Capital expenditures for the quarter were $10.2 million.

Deferred revenue increased 23% year-over-year to $720.6 million.

We ended the quarter with 4,035 employees, an increase of 90 from the prior quarter.

Now for the Q3 outlook.

In keeping with recent historical patterns, ongoing strength of our major drivers, and a robust pipeline, we anticipate continued sales momentum, with sequential and year-over-year growth in the second half of FY15.

That said, we believe the possible continued impact of foreign currency should be considered as we move into Q3.

With that in mind, our revenue target for the third quarter of FY15 is $475 million to $485 million.

GAAP gross margin is anticipated to be in the 82% to 82.5% range, including approximately $4 million of stock-based compensation expense and $2.7 million in amortization of purchased intangible assets.

Non-GAAP gross margin is expected to be in the 83.5% to 84% range.

We anticipate GAAP operating expenses in the range of $257 million to $266 million.

This includes approximately $34.5 million of stock-based compensation expense and $0.7 million in amortization of purchased intangible assets.

For Q3, we are forecasting a GAAP effective tax rate of 37%, and a non-GAAP effective tax rate of 35%.

Our GAAP EPS target is $1.16 to $1.19 per share.

Our non-GAAP EPS target is $1.57 to $1.60 per share.

We plan to increase our head count by 100 to 125 employees in the current quarter.

We believe our cash flow from operations will be at or around $170 million.

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

Thanks, Andy, and good afternoon everyone.

Before I go on to talk about Q2 results and Q3 outlook, I just want to say a few opening remarks on the organizational announcement that we released today.

Firstly, I would like to congratulate Manny Rivelo on his appointment as President and CEO of F5 effective on July 1 this year.

When I announced my intention to retire in October last year, I stated that a key priority would be to work closely with our Board to have a smooth and effective transition plan for my successor.

I will work with Manny and the F5 executive team over the next couple of months to ensure a smooth and efficient hand-over of responsibilities, and then assume the position of non-executive Chairman of the F5 Board.

Al Higginson, who has been our non-executive Chairman for the last 11 years, will assume the position of Lead Independent Director.

I am confident that Manny's understanding of technology trends, his strategic vision, operational experience, and tremendous culture fit with the F5 values will ensure that F5 continues to have a fantastic future.

I'm sure you will join me in wishing him great success in his new role.

Okay, let's talk about our Q2 performance, and our outlook for Q3 and beyond.

Overall, I was pleased with our performance in Q2.

From a sales perspective, the Americas region had a very solid quarter, with double-digit year-over-year sales bookings growth, delivering the internal forecast.

In particular, sales from $1 million-plus deals in Q2 increased significantly over Q1, and this was a significant factor in the Americas region's strong results.

The EMEA region continued to deliver year-over-year sales bookings growth, though the growth was not as strong as we have seen in previous quarters, and was below our internal forecast.

Sales in our APAC region were also below our initial forecast, and sales in Japan were slightly above the forecast.

Our services business continued to deliver solid results and excellent profitability, along with a healthy increase in deferred revenue, which is now approximately $721 million, up 6% sequentially, which should bode well for future business.

From a software perspective, the latest industry analyst report shows a clear market leader in the Virtual Edition ADC market, driven by our ability to provide our solutions as virtual software offerings -- software-only offerings -- across all the major high providers, and our unique orchestration functionality in Big IQ to enable customers to move to software-defined data centers and NFV architectures.

Also, the combination of GBB pricing, Virtual ADC sales, and a solid attach rate of software modules continued to result in solid software growth.

We had a number of a large project wins with our security solutions last quarter.

In our Q1 call three months ago, I mentioned that we had won a large-scale AFM GI firewall project, and a Tier 1 service provider in North America.

This project is now in production.

We received more orders last quarter as the customer rolls out more of the GI firewall solutions throughout their network.

We expect to see continuing business from this project during this fiscal year, and in FY16.

We also plan to replicate the success wherever possible in the overall service provider market.

We continue to believe that our security business will be our largest growth driver.

We expect to see strong demand for our increasing portfolio of security solutions, as customers look to adopt hybrid architectures, deploying applications both in-premise and in the cloud.

As you will recall, we launched our Silverline hybrid application strategy in November, with the initial launch including our subscription-based DDoS service, and our anti-malware and phishing protection service.

We extended our Silverline services platform a couple weeks ago with our industry-leading WAF capabilities.

As the latest addition to F5 Silverline's cloud-based application services platform, the new WAF offering is built on our industry-leading ASM solution.

We now offer our customers leading WAF services in both on-premise and subscription-based cloud offerings.

This new cloud offering provides both ease and speed of deployment, and allows organizations to confidently incorporate cloud resources while protecting apps and data from increasingly sophisticated security attacks, risks, and vulnerabilities.

I was very pleased with the progress we made on our strategic initiatives in the service provider market last quarter.

We had a strong presence at Mobile World Congress, where we showcased NFV solutions that power and secure service provider networks.

Sales in the service provider market were very solid last quarter, with sales bookings at a record high.

The American regions in particular had a very solid quarter, with several wins with the Tier 1 service providers, as well as a number of competitive wins in the cable companies.

We won several competitive replacements last quarter, including the GI firewall project I mentioned earlier, and we had some solid wins with our traffic to LTE solution, including license upgrades as LTE traffic increased in the installed base.

Also, GI consolidation, traffic speeding, and optimization also continue to be good drivers for us in the service provider market.

As I mentioned last quarter, our hybrid application services, based on our Synthesis architecture, and Silverline cloud services, is resonating really well with our customers and partners.

This strategy, combined with the strength of our partner ecosystem in areas like SDN, provide F5 with the opportunity to play a very strategic role, as customers continue to strive for competitive advantage and maximum agility by moving to new technology architectures.

Also, our portfolio of application products and cloud services continues to expand aggressively, which in turn significantly expands our addressable market, and increases the types of revenue streams available to our sales force and partner channel.

As far as the outlook is concerned, Andy indicated that we expect to deliver both sequential and year-over-year growth this quarter.

While we face some potential headwinds as a result of the currency movements in some movements, especially EMEA, I was very pleased with the positive rebound we experienced with the revenue from the $1 million-plus deals.

I continue to believe that the fundamental drivers of our business remain robust.

We remain committed to plan for growth in our business by investing in head count and infrastructure moving forward, whilst delivering world-class operating margins.

I believe that our existing product portfolio, our hybrid application services strategy, and our product road map are not only in line with customer and market trends, but are also key to enabling those trends.

In conclusion, I would like to thank the entire F5 team, our partners, and customers for their support last quarter.

Before we move over to Q&A, I'll hand over to Manny to give you his thoughts and F5's opportunities looking forward, and talk briefly about our strategic initiatives.

Thank you, John.

Before I say a few words on our vision and strategy, I would like to say that this is a very exciting time to be part of F5.

When I look across the Company, I see a collaborative and productive team, all aligned to the common goal of providing fast, secure, and available applications to anyone at any time on any device.

That alignment in strategy and purpose is a testament to the Company you built, and the culture of innovation and respect you championed.

The leadership team, the Board and I thank you for your dedication and commitment to excellence.

We have something truly special here, and I am honored to be given the opportunity to lead it into its next era.

Regarding our vision, over the past years F5 has evolved beyond our traditional data center roots to include a robust hybrid products and services portfolio, including scale-out virtual additions, born in the cloud products, and as-a-service solutions all complementing our market-leading ADC technology.

In addition, our innovative approach towards protecting applications has made F5 a logical addition to many companies' security posture.

Lastly, our broadened ecosystem of technology partners will help us deliver our Synthesis architecture to meet the ever-increasing SDN, NFV, cloud, and security applications opportunities.

In partnership with our leadership team, we will continue to evolve the Company to ensure F5 can deliver application services in the way that makes the most business sense to our customers, whether that's on-premise, in the cloud, or on-demand, and always with the confidence that F5 is defending those applications.

Lastly, our most important asset is our people.

I'll lead in a collaborative, transparent, and respectful way.

In my first month as CEO, I'm dedicated to listening to our employees, to hearing what motivates them, and to hear about their ideas on how to make F5 even a better place to work, and also how best to serve our customers.

I am excited to get started in this new role, and I want to express my gratitude to John and the Board for their vote of confidence.

Now let's hand the call over for Q&A.

(Operator Instructions)

Jason Ader, William Blair.

Thank you, and my congratulations to you, Manny.

Thanks, John, for all the great years.

On the questions I have, first I just wanted to get a sense, Andy, maybe from you linearity in the quarter.

Secondly, maybe for Manny, I know soft ADCs are not a big percentage of sales today.

You just -- virtual ADCs -- but you did refer to them just now.

If the market pivots faster than expected to virtual ADCs, how do you see that affecting F5's business, and particularly the model?

Yes.

First on the linearity, Jason, it was more back-end loaded than we'd normally see in a Q3, but it wasn't like a record, right?

Really more telling was my comments on how near the end of the quarter, particularly in EMEA, APAC, and Latin America, we saw sales drop off.

That's what has led us to deeper look around the foreign currency elements of this, which we think are tied there.

We've been talking with the sales teams, looking at specific deals where we think that was an impact.

That's really how the quarter laid out linearity-wise, and has led us to this look at the foreign currency, and a little bit of a cautious approach around that.

Yes.

Let me just add some to virtual ADCs.

Actually, we see as it being complementary.

We are seeing actually our virtual ADCs grow at a nice clip over the last couple of quarters, and really over the last couple of years.

But what we are seeing is two trends.

One is that new applications are getting virtual ADCs; meaning in today's architectures where either applications are moving to the cloud or they're moving to a much more software-defined data center, we're seeing those virtual ADCs take over.

However, in the same instances, customers are looking for traditional hardware solutions in what we tend to call internally a two-tier architecture, meaning the exterior tier of the data center is usually hardware.

In that level we provide services with our custom-built hardware that provides high throughput, high performance.

Then we apply virtual, if you will, ADCs at the application layer on the back end of the tier.

We think it's actually complementary.

We think that to succeed in the market, you need both the hardware components and the software components working in tandem, providing both on-prem and off-prem solutions.

So you don't see any cannibalization or ASP pressure in the business from it?

No, not at the current time.

Not at all.

Thank you.

Next question?

Hello?

Amitabh Passi, UBS.

Hi.

Thank you guys.

John, the first question for you.

The strength in the service provider vertical -- you mentioned North America.

Was this again you starting to see the benefit of the security win you talked about?

Can you maybe provide a little more insight into the service provider trends by geography?

Yes.

In service provider North America, it was across the board, actually.

All the tier ones -- and I mentioned competitive wins in the cable company.

So yes, security was a big factor.

So was traffic steering, Gi consolidation.

It was a pretty well-rounded quarter there.

Sales in APAC weren't quite as strong.

They had a very difficult comparison from a year ago, where they had very significant growth.

Same in Japan; it was a little bit late again.

We had a very big win from one of the Japanese tier ones last year, so that was down a little bit.

I don't actually have the information in EMEA.

I think it was --

EMEA was relatively flat.

Okay.

They came in line where we expected.

Maybe as a quick follow up, on your GBB program, can you give us a sense where are we, what sorts of attach rates are you getting?

Do you think you're past the sweet spot of the acceleration or the momentum you saw last year?

Any help there would be highly appreciated.

Absolutely.

GBB was interesting, actually, last quarter in the sense that well first of all, great majority still going to best.

Actually I think it might even have been a record percentage going to best that actually either went for better or best.

It was as much as 80%, actually.

Interestingly enough, it was very solid in the Americas.

In North America in particular, it was actually very solid, with pretty significant growth.

We did see a little bit of deceleration in APAC and EMEA, which is actually somewhat counterintuitive, because they were slower to pick up the GBB process.

I actually view that as good news, because we think first of all that's a trend that will continue, because there's a lot of runway in EMEA and APAC.

It was probably linked to the exchange issue, the foreign currency issue, which was the bigger picture of the business.

Very happy with what happened in North America.

Let me say it was still very significant revenue, and very material part of the product revenue.

Excellent.

Thank you guys.

I'll step back in the queue.

George Notter, Jefferies.

Hi.

Thanks very much, guys.

I wanted to follow up on the currency discussion.

I'm trying to get a better handle -- any sense for how much of an impact you guys might have felt because of currency this quarter?

How much did currency factor into your guidance for next quarter?

Can you remind us how much of the business is US dollar or US dollar linked?

To the extent that you see pressure, does that wind up flowing through to F5?

Is that more felt at the channel level?

Any more flavor on the whole currency issue would be great.

Thanks.

Yes, this is John.

Yes, we had time to talk face-to-face and/or video with our sales management in Latin America, as well as in EMEA, and really drill down on it.

EMEA -- to actually give you a number is difficult.

It really is, because if you think of some of the things that we see when you get these currency issues, especially when they're fluctuating quite significantly, your VAR channel, who could make the mistake of taking an order and lose money almost by the time that that order has been paid for by the end user customer.

That tends to make them shy, and we definitely got that feedback from South America.

We definitely got that.

We expect similar things happened in EMEA, but it's a little bit too early to actually give you a number.

But we do -- given what we saw, as Andy mentioned at the end of the quarter in terms of the slip, which we don't really see that often at all from those regions, we're pretty sure it's got to be linked to the foreign currency -- the exchange rate, I should say.

Got it.

Any sense for how much that is incorporated into the next quarter's guidance?

Well, hopefully adequately.

(laughter) That's what we try to do.

Let me ask it this way.

What percentage of the deals that you see do you think the currency issue rears up in?

Yes.

It's hard to -- where we tend to do -- where we tend to -- when we've seen issues like this in the past, micro issues like this in the past, we basically go back to our roots of looking at the close rate percentages.

Hopefully, as I say, we've adopted an appropriately conservative but realistic close rate.

Got it.

Okay, thank you.

Thanks.

Michael Genovese, MKM Partners.

Great, thanks very much.

I wanted to ask about sales tactics for bundles -- the good, better, best -- if those can be used to somehow outgrow the overall growth rate of the ADC market?

What do you think -- what's your current view on what the growth rate of the ADC market is?

If you could just talk about how do you use the penetration of good, better, best to try to out-grow that overall number?

Michael, this is Manny.

Let me try to answer that question.

Yes, we believe that GBB is transforming the ADC market, and the growth rate of the overall ADC market.

The rationale for that is because what we're doing is consolidating a set of services, layer four through seven service, inside a product The traditional ADC product itself was predominantly started out being a load balancer in the early days, if you go back a decade or so ago.

Since then, we've incorporated into that product firewall technologies, secure web gate technologies, service provider technologies.

The list goes on and on

That's part of the value proposition of the traffic management operating system, or big IP, that we bring to market.

By looking at that, we think the addressable market of our solutions is about a $12-billion opportunity for us.

That's what we talked about at the Analyst Conference last November.

We're tracking to that.

We monitor that very closely.

If you look at just the ADC market, right, in the old definition, that would be about a $4-billion market.

We think we've added to the new definition approximately $8 billion of incremental TAM.

Do you have a view, just on the growth rate of the traditional ADC market?

How -- I guess industry analysts would probably be countering it, but are there any of those numbers that you endorse?

Yes, we're not -- this is John.

We're not trying to adopt that, because remember, what we're doing is we're basically making sure that we get into a varied number of markets, not least security.

The more that we are successful in security, and we feel good about our progress, the more we'll get into that faster-growing market.

I could give you a number of goals in security, but I don't want -- that's going to be misleading, because it needs to be a bigger percentage of our business.

It's growing.

That's our strategy, so rather than giving you one number of ADC market, remember we're using ADC to go into other markets, hopefully fast-moving ones like mobile traffic and security.

Great.

Well, thanks for allowing the question, and congratulations to both of you.

Thanks.

Mark Kelleher, D.A. Davidson.

Great.

Thanks for taking the questions.

Just wanted to look at the $1-million deals.

You said those increased significantly in the quarter.

That's great.

What's your anticipation as we move into the next quarter?

Does that momentum continue?

Do we make up -- does the components of that guidance make up smaller deals?

What's your thought there?

This is John.

I think what we saw there was I think we got proved right.

On last quarter's call we said we believed that the reduction was due to the Q4 push emptying the pipeline.

I think we're back to normality in the $1-million deals.

Now obviously time will tell on that; but that's how we feel when we look at the pipeline, and we listen to the quarterly business review's on it what's being forecast by the sales force.

Okay.

But let me remind you, because I'm not going to be here, is that Q1 next year, I think you're going to see a very similar scenario.

Okay.

As a follow-up, or maybe a second question, the break-out between product revenue and service revenue.

Product has been the decelerating, with service revenue growing quite rapidly.

Do you see that dynamic continuing?

What's the sales model shift?

Is that going to continue to push towards service model and subscription revenue?

Some thoughts on the growth of product revenue would be great.

Yes, when we're looking today at that mix between product and service, I really think it's more the service tends to trail product, right?

We're seeing a lot of good service growth off of last year's tremendous product growth.

If we don't get product re-accelerating again, we'll probably see service start to slow down, but over a longer period of time.

That's the dynamic there, but --

If you look at obviously product revenue acceleration is always going to be our major financial goal, as we've got the rest of the business I think in good shape in terms of profit, et cetera.

That's always a thing.

The two big areas there are service provider and security, and to make sure both in that.

There's going to be other areas where we see growth areas.

Obviously subscription is one where it will be a while before we see the growth; but once we see it, it's the gift that keeps on giving.

Number one focus, product revenue growth; but meanwhile we are also creating this other channel using subscription services and Silverline to make sure that we've got good recurring revenue at the product level as well as the service.

Just for clarity, in case I missed something there, our subscription revenue that comes from the Silverline service goes into our product revenue, so it will be a part of that.

The interesting metric that as it gets more meaningful, that we'll start to look at more closely is deferred revenue and the growth there, obviously, because that's a set-up for future revenue.

We'll talk about more -- that more in future quarters as it becomes more meaningful.

Okay, great.

Thanks.

Rod Hall, JPM.

Yes.

Hi, guys.

Thanks for taking my question.

I just wanted to follow up on the currency question.

George had asked you guys what the dollar-linked or dollar exposure is versus foreign currency.

I think you guys price in local currency external to the US, but I just wanted to double-check that, and then had a follow-up.

Yes.

Actually, almost all of our sales are in US dollar.

That goes to the distributor, and then converts to local currency at that point -- which is why John was talking about we work with the channel on these currency issues, and historically, tended to have addressed them on a deal-by-deal basis.

So far with what we're hearing, we think that's how it's going to continue, but we'll see.

Have you guys -- the follow-up then Andy is given that, are you -- so you haven't accelerated price declines in dollars to try to compensate for the local currency fluctuations, at least in some of the regimes where currencies are really badly impacted, like Brazil and Russia and so on, or have you not really moved to do that sort of thing yet?

Yes.

No, we've not responded with lowering pricing, and never really have and probably won't.

I think we'll be addressing it through our discounting process on a deal-by-deal basis, working with our channel partners as the deals merit, and they come to us, and we figure out how to work it together so we win.

Okay.

I also -- on services, if I could follow up, I know John, you talked about consulting services, people coming to you guys, and asking you to do more and more of this.

Is there any -- do you have any ability to quantify that for us, or give us some idea for how that part of services is growing for you?

I assume it still is growing?

This is Julian.

That part of the services business is growing slightly faster than the maintenance support business.

But over the course of the last 18 months, we've been employing strategies of working with our own sales partners, and expanding the capabilities to the point that we sub-contract to those people, as well.

Also, to providing more of that consulting service remotely rather than going to site all the time.

Always focused on product sales, but at the same time trying to maintain better margins, which is what we've done over the past year.

Jeff Kvaal, Northland Capital.

Yes, gentlemen.

Thank you very much, and let me add to my congratulations to those who have come before me.

I look forward to working with you, Manny, and John, I don't look forward to not working with you, I guess is the way I would put it.

(laughter).

Okay.

Could I ask, the product revenue growth, obviously, we've been watching this for many years, and asking about it every quarter.

It looks like it may be flat to down again in the next quarter.

How long do you think it may be before the current -- let's assume that the currency normalizes at these levels.

How long do you think it might be before the product revenue would start to drift back up?

This is John.

I'm going to make an excuse -- I'll lead with that.

But given what we saw in America last quarter, where they had really solid rebound -- not just in the $1-million deals, but the actual sales, if we had not seen those -- this is our opinion, now -- if we hadn't seen those currency, we wouldn't be answering this question right now.

We have to balance that.

The key for us is to keep focused on creating technology and security, and the big drivers that we see, making sure that we execute on areas like the ACE opportunity, which we still believe is there.

In fact, there's a number of deals going this quarter, then we'll see the results.

That's our focus, but meanwhile there are some headwinds in between, obviously, Michael.

I'll add to that is that we are continuing our innovation cycle; and we'll see specifically coming out later this quarter, our next release of technology and products into the market segment.

Actually, it's the quarter after, I apologize, Q4, that you'll see that innovation come out.

Expect to see from us continued added innovation on two releases predominantly a year.

That will continue to build TAM for us and new products in the market.

Okay.

Well, that leads me in a new direction, I guess.

Do you think it is possible that some of the revenue that you might have liked to have seen in the March quarter and the June quarter did not arrive for some other reason?

Maybe that's because they are expecting some of these product refreshes, or maybe it's just tough comps, or what have you?

Are there other things going on possibly beyond the currency?

I don't think so.

This is John.

First of all, and we heard this from our sales force -- sales management in North America and EMEA this way.

They were very optimistic about our competitive position, so we don't see that at all right now.

We think we've got a great area there and it will continue.

It's up to us to keep driving those solutions and that innovation that Manny talked about, and product revenue will follow.

Just to clarify, most of the innovation we're talking about here is not physical hardware.

It's actually software innovation, so customers can upgrade to that innovation, specifically within our support capabilities.

We offer them that opportunity to move to the most recent software cycles.

They're not penalized by any means by not having the technology today, and when the additional software functionality becomes available, they'll do an upgrade.

Thank you, gentlemen.

Thank you.

Rohit Chopra, Buckingham.

Yes, thanks for taking the question.

Congratulations, John and Manny.

I had a question, again, just about the end of the quarter and the softness.

I know you mentioned currency, but did you see anything related to competition?

I know there's a few competitors out there who are a little bit desperate; but maybe they were accounting for the weakness at the end of the quarter?

Maybe that's the first question.

The other question I had -- and John, maybe you can help me out on this one -- but it comes back to product growth and services growth.

Is foreign -- what's the makeup of the services renewals or service maintenance contracts?

Are they mostly foreign?

The reason I'm asking is maybe the foreign buyers -- are they holding off on maybe some upgrades or some new purchases, and they're just sticking with their existing solutions for a little bit longer, just given the currency?

Have you looked at that?

Let Julian answer the services thing, because I think definitely the way you've asked the question it's not the situation.

Then we'll talk about the competitive.

On the services maintenance renewals, we had a strong quarter across the globe.

The proportions really mirror the product revenue portions from the parts that we talked about -- roughly just under 60% North America, and the rest of the world the rest.

EMEA and North America were our two outstanding performers, so really no affect whatsoever in that regard.

Rohit, just to add around the market share, over the course of last year we grew market share.

We felt really good about that, taking a leadership -- well, maintaining A, the leadership position in the total market; but also taking the leadership position in the software-only market.

We anticipate this quarter that we'll gain market share across the board.

Our competitors continue to be Citrix, A10, Radware.

Those are the primary competitors we see out there.

Our selling motions, our win rate in the field, everything is favorable, very favorable.

We expect another year of continuing to gain market share.

Can I ask a quick follow up, Manny.

It didn't seem like when you had your part of the presentation, that there was going to be anything different, but if John wasn't in the room, what would you change?

(laughter)

John is in the room.

He's right there.

But no, I think for us, really, I've taken this question a couple of times.

Where I think the focus is going to be short term is first of all the transition.

There's no question about we're going through a quarter here where we're transitioning.

We want to make sure that we continue to execute our financial model as well as all of our customer commitments.

But what we're aggressively also working internally is our FY16 and beyond strategy.

That's how we're going to balance not only the short-term opportunities we have, but also the long-term opportunities to be able to succeed.

As we evaluate that, you'll see us rolling that out at the Analyst Day in November, just like we always do, what our strategy is.

There's some areas there that we're going to double-down and accelerate.

Some of those are probably pretty obvious -- things like security, which we have a lot of traction, and there's other areas where we might consider pulling back a little bit on investments just to capitalize on those new areas.

That's the area that we'll be evaluating over the course of the next quarter or two.

Thanks, Manny; and John, appreciate it.

Brian, this is John Eldridge.

We're going to take two more calls and then wrap it up.

Paul Silverstein, Cowen & Company.

Great.

Thanks, guys.

I recognize you been asked the question six ways to Sunday, so that said, going back to currency for one minute.

I suspect it's probably impossible to tell, but John, Andy, Manny, have you seen with respect to US-based customers, larger customers who do business overseas, where they too have been impacted perhaps to one extent or another in terms of a decrease in revenue over the last nine months with the appreciation of the dollar, have you seen any sign that they're cutting back on their IT purchases?

Historically has been the case, the first thing that gets cut is networking.

Are there any signs of that?

Then on the Gi Firewall deal that you all called out, in terms of the dollar contribution, can you give us some sense of the magnitude?

I heard you say that you expect to continue through 2016, but I guess I'm trying to get a sense of the concentration risk from that one deal?

Okay.

Actually, let me answer that while it's on my mind.

I think in the last call I talked about a couple of transactions more than $1 million.

We talked about another transaction happening this quarter, $1 million plus.

That's the type of -- we expect -- and remember this is our roll-out.

This is not something -- we expect to see that throughout the fiscal.

I'm not saying every quarter we'll see it.

I'm not committing that.

But we expect to see that type of transaction happening as they roll-out the Gi Firewall to the network.

Another thing I said was its through -- we think it will go through 2016.

We don't see any concentration, actually.

Almost the opposite.

The main thing we want to do is actually is make it work, which we're very happy with the way it's gone into production, and also to replicate it, and the other.

Let me just add something to that.

Although we talked about that one transaction, we've also seen other Gi Firewall deals that we've won.

They tend to be much more in the software space, NFV type projects, from that implementation point of view.

Those are material also in size.

It's not concentrated as per one account.

We're seeing that traction across various different service providers, some which are going to hardware appliances, and some which are going to software architectures.

And then -- sorry, to your initial question about US companies being impacted in some way if they would be multinational business.

Where we would hear that is through the channel or our sales force that services those accounts.

Even anecdotally, we're not getting any indication of that, that would give us concern there, with the US companies doing business overseas.

So all the near-term weakness, Andy, you would attribute to the dollar impact on overseas business, not US?

Yes.

On the flip side, you look at EPS and look how the benefit on our EPS from foreign currencies.

All right.

One quick follow up.

Andy, I trust, I know you're saying that the virtual editions are incremental and not cannibalistic; but I also, if I recall, historically you've said on the issue that virtual editions go out about 80% of the price of the hardware, with a wash to the bottom line -- that it's neither better or worse.

Does that still hold?

Yes.

What we've seen historically, if you look at how we price the virtual editions, it's roughly $12,000, which is 80% of our entry-level box, which is about $15,000, which has about 20% margins.

Entry-level it's kind of a wash.

But what we've seen to date is that those deals tend to be larger, because they choose to go with a much more horizontal type approach, which pushes them towards many more instances.

That's what we've seen.

Not saying that it won't change as things evolve, but at least to date that's where we're at.

I think just to add some additional context to that -- this is Manny.

The way to think about it is when we tend to sell the virtual editions, they tend to go out one per application.

Sometimes when the hardware is sold, it's many applications from one appliance.

You're seeing it picked up in volume, which is Andy's point, versus concentration at the appliance level.

It tends to be almost a wash.

Thanks, guys.

Sanjiv Wadwani, Stifel.

Thanks so much.

Let me add my congratulations to both Manny and John.

Two quick questions.

John, just on the currency issue, just wanted to get a flavor.

When you're seeing these issues, are they coming in the form of a lower deal size?

Are the deals getting pushed out?

Any color over there would be helpful?

Then on Cisco ACE, I know you mentioned it briefly, but are you still seeing a lot of opportunities out there, or is this starting to get a little bit mature, since you've been attacking that installed base for well over a year now?

Thanks.

Yes.

On the deal size, we have -- we've seen some of that.

Again, it's anecdotal in the sense it's coming from sales management as I'm looking, thinking what happened here?

We forecast a number and then towards the end we missed, and we don't often do that.

Then when you look at some of the actual orders, especially towards the end of the fiscal -- the quarter, I should say -- we did seem some reduction on add-ons coming.

We did say some of that happening.

In other words, the customer really needs the basic optimization and steering, but maybe doesn't opt for an additional module.

There was a bit of that went on.

Again, it's hard to actually come up with a specific number on that, but we did see some of it.

Then ACE.

No, ACE we think we've still got a very big opportunity there.

I mentioned I think just briefly during the call that when we went through the Americas QVR this week on Monday, we went through it in detail.

It was a bunch of really big transactions that we're forecasting to close are ACE opportunities.

Then, of course, remember that once we do that, if we get a big transaction that tends to mean it's a bigger company.

We sell security, we sell more add-ons, we sell more into the account, and we've got very good examples of that.

Yes, no, I think it's still a very good opportunity for us, and we're very focused on it.

That's why we keep measuring it and looking at it each quarter.

Got it.

Thank you.

Thank you all for joining us for this call.

Rest assured we're going to keep our heads down and do our best to bring in a good quarter.

We'll talk to you all again at the end of Q3.

Okay, thank you.

Then that does conclude the call for today.

You may disconnect your phone lines at this time.