F5 Inc (FFIV) 2015 Q3 法說會逐字稿

Good afternoon, and welcome to F5 Networks' third-quarter 2015 financial results conference call.

(Operator Instructions)

Also, today's conference is being recorded.

If anyone has any 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, Laina, and welcome of all you all on the line to our earnings conference call for the third quarter of FY15.

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

Kristen Dimlow, our new EVP of Human Resources and the other members of our executive 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 release is available on our website, F5.com.

In addition, you can access an archived version of today's live webcast from the events calendar page of our website through October 28 from 4:30 PM today until midnight Pacific time, July 23, you can also listen to a telephone replay at 800-879-6771, or 402-220-5335.

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 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, described in detail in our SEC filings.

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

And now, I'll turn the call over to Andy Reinland.

Thank you, John.

In the third quarter of FY15, F5 delivered solid results that reflect growing demand for our expanding array of products and services.

As more large organizations deploy hybrid architectures, we continue to see momentum in sales of our software offerings, both as modules on our purpose-built hardware, and as standalone virtual editions.

During Q3, we also saw the beginning of what we believe will be a steady ramp in sales of our subscription-based Silverline services.

These trends, combined with the ongoing success of our good-better-best sales motion, demand for our security products, and continued traction with our key partners, all contributed to the quarter's positive results.

Revenue of $483.6 million grew 2% from the prior quarter, and 10% year-over-year, and was at the high end of our $475 million to $485 million guided range.

GAAP EPS of $1.29 per share was above our guidance of $1.16 to $1.19 per share.

Non-GAAP EPS of $1.67 per share also exceeded our guided range of $1.57 to $1.60 per share.

The strength in EPS was driven by our solid revenue and operating margin results, and lower than expected tax rate during the quarter.

Product revenue of $248.8 million, up 2% sequentially and 5% year over year, represented 51% of total revenue.

Service revenue of $234.8 million increased 3% sequentially, 15% year over year and accounted for 49% of total revenue.

The Americas accounted for 58% of revenue during the quarter.

EMEA contributed 24%, APAC 13%, and Japan 4%.

On a year-over-year basis, Americas revenue grew 13%, EMEA revenue grew 14%.

Conversely, APAC revenue declined 6%, and Japan revenue was down 2%.

Enterprise customers represented 66% of total sales during the quarter.

Service providers accounted for 20%, and government sales were 14%, including 6% of total sales from US federal.

In Q3, we have three greater than 10% distributors: Westcon, which accounted for 19.2%; Ingram Micro, which represented 16.7%; and Avnet, representing 13.5%.

Our GAAP gross margin in Q3 was 82.3%.

Our non-GAAP gross margin was 83.6%.

GAAP operating expenses were $257.8 million, at the low-end of our guided range of $257 million to $266 million.

Non-GAAP operating expenses were $224.3 million.

GAAP operating margin was 29%.

Our non-GAAP operating margin was 37.2%.

Our GAAP effective tax rate for Q3 was 33.9%.

Our non-GAAP effective tax rate was 33.5%.

Turning to the balance sheet, cash flow from operations was $172.5 million.

In Q3, we repurchased just over 1.2 million shares of our common stock, at an average price of $124.92, for a total of $150 million, ending the quarter with approximately $1.16 billion in cash and investments.

Approximately $624 million remains authorized under the share repurchase program.

DSO at the end of Q3 was 49 days.

Inventories were $30 million.

Capital expenditures for the quarter were $21.2 million.

Deferred revenue increased 20% year-over-year to $742.5 million.

We ended the quarter with 4,110 employees, an increase of 75 from the prior quarter.

Now for the outlook.

Building on another quarter of solid momentum with our key drivers, we believe we will continue to see strong year-over-year revenue and earnings growth.

Our revenue target for the fourth quarter of FY15 is $500 million to $510 million.

GAAP gross margin is anticipated to be in the 82% to 82.5% range.

This includes 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 $267 million to $276 million.

This includes approximately $38.5 million in stock-based compensation expense and $0.7 million in amortization of purchased intangible assets.

The stock-based compensation guidance reflects a one-time approximately $5 million increase as a result of the CEO transition, as outlined in our 8-K, filed April 22.

For Q4, we are forecasting a GAAP effective tax rate of 37%, and a non-GAAP effective tax rate of 35%.

Reflecting the increased stock-based compensation expense, our GAAP EPS target is $1.26 to $1.29 per share.

Our non-GAAP EPS target is $1.72 to $1.75 per share.

We plan to increase our headcount by at least 125 employees in the current quarter, and we believe our cash flow from operations will be at or around $185 million.

And with that, I will turn the call over to Manny Rivelo.

Thank you, Andy.

I would like to thank everybody for joining F5's 2015 Q3 earnings conference call.

Overall, I am pleased with our performance in Q3, as reflected by our record revenue and profitability.

Among the notable signs of our progress this past quarter, we significantly grew our software revenue, with the uptake of our good-better-best packaging driving million-dollar plus deals.

Moreover, our standalone software module attach rates were solid, especially the security modules.

We saw major deals from service providers in the areas of Gi LAN service consolidation, security, network function virtualization.

And we're excited about the progress we saw on our Silverline anti-DDOS subscription service, plus the recently-launched Silverline web application firewall, that has opened up new use cases for customers.

From a regional perspective, we had a strong quarter in the Americas, with bookings ahead of our internal expectations.

In EMEA, we saw bookings growth rebound of a slower Q2 performance, with particular strength in northern Europe.

Bookings in our Asia-Pac and Japan regions were slightly down year over year, in line with our expectations heading into the quarter.

Now let me drill down into the specifics of our major business drivers, which include core, security, service provider, professional services, and our partner ecosystem.

In our core business, we continue to help our customers leverage our Synthesis architecture to deliver their applications in the most efficient, secure and cost-effective manner.

This includes optimizing their own data centers, as well as leveraging both private and public clouds.

Key to this is offering all of our products a software that can run on the major industry hypervisors, or on top of a high performance hardware.

Software is at the core of everything we do.

Over the past three years, quarterly revenue from the sales of software modules and virtual editions has more than doubled, accounting for more than a third of our product revenue in Q3.

The growth of our software-only business is reflected in a recent industry analyst report, which reported that we grew 2.5 times faster than the general virtual ADC market, making us the market leader.

As more of our customers deploy hybrid solutions and adopt our good-better-best offerings, we believe this trend will continue.

An example of a key customer win validating our hybrid applications services strategy is a large hardware and software deal with an academic medical center, that has standardized on F5.

Leveraging our Access Policy Manager, specifically the portal access, we are helping them drive down their total cost of ownership, while creating the flexibility to move their applications between different cloud providers.

In addition, we continue to see success with our platform refresh in the Cisco ACE replacement programs, with many of our customers expanding their solutions to include our enhanced software modules.

Lastly, our user community, DevCentral grew nicely at 38% year over year, with over 200,000 members, further demonstrating the value of our TMOS programmable architecture.

Our security modules remain a major growth driver for us.

Given this past quarter's highly visible cyber security attacks, more customers from an increasing diverse pool are approaching F5 for our ability to secure applications, manage user policy and access, and mitigate application attacks across traditional data centers, and public and private clouds.

As a result, we had a number of notable wins this quarter, including a branch of the US government, a prestigious medical research group, both of whom needed to secure the organization's remote access capabilities.

In addition, a multinational defense contract to purchase our Access Policy Manager for Single Sign-On federation and three national carriers came to F5 for a variety of security solutions.

Chief among them was our DNS security for mobile devices.

As you may recall, we also launched our Silverline DDOS mitigation service last November, and this past quarter, we launched our web application firewall service, built on our industry-leading Application Security Manager.

We have seen solid early adoption of these services.

For example, a household name in retail that is an F5 customer added anti-DDOS Silverline protection in Q3 to their global web properties.

Over the next several quarters, we plan to deliver additional Silverline services, including an upcoming iRule catalog that can be leverage for various application solutions, allowing zero-day vulnerability protection.

In addition, we will deliver hybrid on and off premise solutions that allow seamless interoperability between our Silverline SaaS offerings and BIG-IP on-premise solutions.

In April we opened the security operations center in Seattle.

This gives us 7x24 support to clients, helping mitigate web fraud, malware, phishing attempts, and to combat DDOS and web application attacks through Silverline services.

On the service provider side, major carriers across the globe continue to expand their use cases with F5, driving down their costs and expanding their monetization strategies.

In particular, our solutions around Gi LAN service consolidation, network function virtualization, Gi firewall and diameter routing are helping service providers manage mission-critical issues like traffic management, increased mobile application delivery, and security.

In Q3, we signed our largest service provider security deal to date, a multi-million dollar agreement with a domestic Tier 1 carrier.

Meanwhile, a major operator in Asia-Pac leveraging two of our key ecosystem partners recently achieved SE certification for the F5 NFC solution, positioning our virtual editions and network functions.

During Q3, our services business continues to produce solid results, with 15% year-over-year revenue growth.

New and renewed service maintenance contracts drove 20% year-over-year of deferred revenue, totaling $743 million, which ensures a positive revenue stream for quarters to come.

From a partner ecosystem perspective, we continue to see great momentum in our partnerships with the likes of Amazon, Cisco, VMware and Microsoft.

I can point to competitive SDN, cloud and BDI wins at media companies, technology companies, and large US retailers.

We are confident that our current and future road maps position us well in helping our current customers and future prospects migrate their application services to software defined infrastructures.

In the meantime, as CEO, I want to ensure that we are continually innovating, delivering best of breed products for our customers, and expanding our addressable market.

Key for our success is continuing to invest in the right people.

To help F5 reach the next level of growth, we have hired a new EVP of Human Resources.

Kristen Dimlow has joined us from Microsoft, and she will be focused on recruiting and retaining world-class talent.

Another organizational change is the transition of the worldwide sales team to a new leader.

After 11 years of service, with sales that rank in the billions, Dave Feringa has decided to step down on October 1 to spend more time with his family on the East Coast.

I want to thank Dave for all that he has built at F5, especially the strong global sales team, and our lead position in the ADC market.

We are actively looking for Dave's successor, and plan to announce our decision shortly.

As you have heard from Andy, we've had a solid year thus far, and look forward to a strong finish in Q4.

We will continue to focus on ensuring that our customers' applications can run where they run best.

Our emphasis will be on driving top line growth, particularly for product revenue.

I am excited about what the future holds.

In Q4, we will launch our next version of BIG-IP, version 12.0.

This release will help our customers navigate their application-centric environments without compromising our security or operational efficiency.

With new features like modern pictographic cyber support, HTTP 2.0, single sign-on enhancements, hyperscale DNS, and expanded SCM and cloud orchestration and management options.

As well as early access features for our next generation of iApp and iRules.

We expect this release to open up over $500 million in additional addressable markets.

For insights into our longer-term plans, I want to spend a few moments on our vision and strategy.

We help organizations deliver the fastest, most secure and reliable applications to anyone, anywhere, on any device.

We are delivering on this vision through flexible scale-up and scale-out architectures, that means we can provide our customers with a consolidated set of application services, on premise, in the cloud, and as a service.

Moreover, we know that applications have become more prolific and dynamic.

Operational complexity has become the primary constraint holding organizations back.

F5 is eliminating this complexity, while simultaneously driving down the total cost of application ownership, via centralized management, orchestration, and analytics-driven insights.

We call this F5 Synthesis hybrid application services, and it is the cornerstone of our business and technology strategies.

In closing, I would like to thank the entire F5 team, our partners and customers, for the support last quarter, and we look forward to a great Q4.

I will now open the call up for Q&A.

(Operator Instructions)

First question is from Vijay Bhagavath from Deutsche Bank.

Sir, you may ask your question.

Congratulations, Manny.

It's a great print.

Especially for you around the competition.

Recently we have heard in the news on activists taking a role in Citrix.

So any thoughts on the competitive dynamics playing versus Citrix and NetScaler in the field?

For example, would you look to proactively refresh NetScalers to Web 2.0 customers?

That is the first part of the question.

Thanks.

Vijay, thanks.

Appreciate the kind words.

So yes, competition is something look at very closely.

As a matter of fact, just earlier this week we did our America's QVR, and we review the competition every single quarter.

The competitive trends haven't changed significantly.

I think you've seen over the last course of the last four to six quarters, that we've been gaining market share in the market.

We see that as going very well for us, and our traditional competitors we think are in a position that we know not only how to compete against them, we have superior solutions.

You will see us continue to expand our programs, which we have aggressively focused on things like Cisco ACE replacement, to also conclude the competition.

So we know that there's opportunity there.

We're competing with them directly.

We're aware also partnering with companies like VMware and tackling their VDI space, and you should expect to see more of that over the course of the next 90 days.

Excellent and a quick follow-on for Andy.

This will be around Catterton?

We get this question a lot from clients.

Any thoughts on an accelerated buyback, any thoughts on M&A, where would you be looking into?

Thanks.

Yes, so on the buyback, that something that we address every quarter with the Board.

I don't think -- I think if you look at how we have performed on our buyback over the last couple of years, we are probably one the most aggressive companies out there, in terms of percentage of buyback to our cash flow.

So the concept of an accelerated buyback or anything like that, that's something we may go with the Board, discuss with the Board, but nothing to announce about that right now.

And then on the M&A, we continue to look very actively, anything that we believe can accelerate our roadmap, we are going to look at very seriously.

And beyond that, really no change to the strategy.

The only thing I would add, Vijay, it's Manny.

On the M&A side, it's something that we are very active on.

We look at a lot of deals, and we look at deals, as Andy said, to enhance our portfolio, consolidate services inside the portfolio from a roadmap perspective.

So we will continue to do that, as we see fit.

Obviously, the market is a little frothy right now, right, to be blatantly honest.

But that doesn't mean that we will slow down our activity.

Excellent.

So this is clearly a positive surprise.

Thanks again.

Thank you.

Thank you.

Next question is from Alex Henderson from Needham.

Sir, you may ask your question.

(Operator Instructions)

Alex, are you there?

Let's move on.

Thank you, sir.

Next question is from Ittai Kidron of Oppenheimer.

Sir, you may ask your question.

Congratulations, Manny, on the first quarter as CEO on the public call, so congratulations, a great start to the quarter.

I had a couple questions.

First of all, looking at your federal business, I went back for the last five years, in fact I don't remember a quarter where the June quarter was actually sequentially up from March.

So clearly great result over there, but how do you make us feel comfortable that you aren't pulling from September the fiscal year-end quarter into June?

So you could give us some color on US fed, that will be great.

And then second to you, Andy, 75 employees hired.

I think your target was north of 100, so any color on why is it you are not able to get the people you want?

Are they hard to find, were you distracted, how do I think about that going forward?

Ittai, it's Manny, just on federal real quick.

So we won't provide, as you know, guidance into the future quarters, but what we see in federal is just a strong pipeline of business, right?

There's been a lot of projects in the federal market space.

I think we've been telegraphing that, that it's not for lack of visibility into the project.

It's in the past, and more for lack of budget into that.

So we saw a very strong quarter.

We anticipate, in typical fashion, right, that the federal has its largest quarter usually in our fiscal Q4, so we don't anticipate that changing.

And then Ittai, the 75 increase, you are right.

We were hoping to be well north of 100, and it's a tough market for hiring out there, and we tend to be pretty picky.

So that's why the guidance, this time we said we want to be in excess of 125.

We brought on Kristen as EVP of Human Resources, and that's one of the areas of focus that she's been tasked with attacking.

So we want to hire, I think if you go out to our website, you will see a lot of postings, and we are trying to be as aggressive as we can about it.

Very good.

Good luck.

Thank you.

Next question is from Jess Lubert from Wells Fargo Security.

Sir, you may ask your question.

I have two for you.

The first, I was hoping you could provide some additional insight into the growth you're seeing in the software business.

How much of that is coming from virtual ADC versus security?

And then perhaps longer-term, as this transition from hardware to software as a service business occurs, should we be expecting product growth to remain in the low single digits for a while, or would you expect that to reaccelerate as comp sees in FY16, and then I've got another one.

Okay.

So let me at just address the software growth.

So, as you know, and we've talked about this in the past, our business is predominantly software.

What goes into our platform tends to be predominantly software, and we have been seeing that growth increase as I pointed out in the comments, over the course of the last three years.

We continue to expect that to increase.

But I want to be very clear.

It's not as if the market is rapidly transitioning from software to hardware.

What we're seeing is a new set of applications that require much more of a scale-out solution and/or applications that are going directly into cloud environments.

We actually think that the future architectures have two tiers associated with it, and what I mean by that is an ingress tier into the data center, that requires high-performance hardware to mitigate traffic, whether it be firewall services, DDOS attacks, and all of those capabilities we provide using our hardware.

On top of that, what we see is the second tier, which sometimes tends to be much more per-application tier which could go to VEs, so we think the future will have a mix of both hardware and software.

And then the other part, on -- are we going to see cannibalization of the hardware business?

The way we price our VE relative to our hardware, is on par, from a unit pricing perspective.

And I will just give you an absolute data point so you can have that.

If you look at a 5-gig virtual edition of our product, it's about $26,000.

Our BIG-IP 2200 is about $28,000, so it's almost on par, and those are both 5-gig devices inside the environment.

So what we're really seeing is customers making a decision much more on whether they want accelerated performance, and/or they want the flexibility of the software for scale-out architecture.

So we don't anticipate that to be a rapid cannibalization movement by any stretch of the imagination.

Yes, and then to future growth rates, Jess, we don't talk about that, or give that out, but we believe our opportunity is there, and we need to execute against that, and driving top-line growth is what we're all about as an executive team, and I think you'll see us continue pushing that and investing to make that happen.

And then secondly, I was hoping you that comment on the carrier business?

It looks like it ticked sequentially.

Do you expect that to improve during the second half of the calendar year?

And it sounds like you did sign a few big deals in the quarter.

Can you provide any insight as to when you think you'll start to recognize revenue on some of those larger opportunities and carriers?

Yes, so we are having good momentum in the carrier space, and as you know, the carrier business tends to be a little lumpy and project-based.

We did see our largest security Gi firewall win with a domestic Tier 1 operator.

It's been repeat business, and we continue to see that ramping up.

We continue to see that same traction in other theaters.

But I think what's also very interesting is that service providers are moving very rapidly to software-based architectures using things like NFV, network function virtualization.

And our products, because we provide the same feature functionality whether it be on accelerated hardware and/or those virtual editions are very well suited.

We are seeing a huge uptake in proof of concepts around NFV.

We are seeing that movement really, really rise.

So that's future opportunity for us.

Early days, like we've spoken about, but very exciting for us.

And then we did take some revenue in the current quarter on the deals that we talked about, and there will be some next quarter, too.

Thanks.

Keep up the good work.

Thank you.

Next question is from Simon Leopold from Raymond James.

Sir, you may ask your question.

Great.

Thank you for taking my question.

I wanted to see if you could talk a little bit about the effects of foreign exchange in the quarter.

It sounds like a number of companies in the technology space, or more broadly, are feeling effects from either demand or exchange rates, given the change in rates, particularly in Europe, and a little bit in Asia.

So I know you sell in dollars, you don't have European direct competitors, but if you could talk about the dynamics of foreign exchange, and whether or not you had to do discounting in order to help out the customers overseas?

Thank you.

Yes, so in both APAC and LatAm, we did get some messaging from our sales organizations that the currency did impact the business.

It just, it tends to slow things down, because people want a stable currency, and so we saw a little bit there.

In Southern Europe, it's a little different.

It could have been currency, there's also macro issues, but that was slower than we would like to see.

And still looking at that.

We haven't really had to do much additional discounting.

It's more working with the sales teams and the partners to get a situation where the currency stabilizes, and we can execute the deal.

But we haven't really had to address it through discounting.

And have you had any pushback from customers asking for discounting, or is it simply this is what it is?

No, usually what happens, because we sell through resellers and distributors, it will come through the channel to us, to request for us to partner with them to work a deal, and we just haven't been getting those types of requests.

I think it's more about the stability of the currency than so much the dollar change.

Great.

Thank you.

That's very helpful.

Thank you.

Next question is from Troy Jensen from Piper.

Sir, you may ask your question

I also wanted to offer congratulations to Manny and team on the sales quarter here.

Manny, curious to know, how much do you think remains on the Cisco ACE replacement opportunity?

Seems like we're pretty long into the process here.

Yes, it's a great question, Troy.

So we been executing to that now for about a year a half.

We still see opportunities.

Believe it or not, we're still seeing large significant opportunities, but the low-hanging fruit you could argue has probably been picked in the market.

What we're seeing is two things.

We are seeing additional opportunities that tend to be not the large marquee accounts, much more the mid-market that we're going after, at this point in time.

And then what we are seeing is repeat business, either because these were large installed bases that are being consumed over time, and customers are turning dozens or hundreds of devices at a time, so they repeat that purchase cycle.

But what we also see when they repeat that purchase cycle, we see them consuming our good-better-best licensing modules, or our software modules.

Meaning that we're having a deeper penetration and we are swapping out our traditional ACE load balancer for really an ADC platform and our service consolidation platform.

So that bodes very well for us, and I think that is continued business for quarters, if not a year plus, to come here for us.

Okay.

And maybe a follow-up here for Andy.

Silverline sounds like it's going well.

I was just wondering if you could just size that for us, whether the revenue contribution -- I also understand it's probably more on the deferred rev side, so anything that can help us gauge the success would be helpful.

You're right, it's about -- deferred revenue really is the metric that we will start to put out there.

It's early days.

I think that the message we're putting out there is we have a set of expectations for that business, and we are ahead of that plan, and we feel good about it, and we feel good about the conversations that it's creating with customers.

We think it's a great add to our overall offerings, and we will continue to expand it, and I don't of Julian wants to add anything.

Just to say, it really comes back to the hybrid offering.

Half of the deals are from existing customers with on premise product and functionality, and then they're bringing Silverline in, and the other half are, from Silverline that's brought us into on-premise deals of the same type.

And we seem to be doing well against the competition, and we're very pleased to be sticking to the plan.

Keep up the good work, gentlemen.

Thank you.

Next question is from Kulbinder Garcha at Credit Suisse Research.

Sir, your line is open

This is Sami for Kulbinder Garcha.

My question is, can you tell us about the pricing difference between virtual ADCs and physical ADCs, and could you tell us also what the sales mix on virtual versus physical has been so far?

We don't provide sales mix, but just to give you an example I just provided a moment ago.

I'll give you a different unit.

So as you look at a 10-gig virtual.

A 10-gig virtual is $30,000.

A BIG-IP 4000 is $30,000.

A BIG-IP 4200 is $42,000.

So it's almost comparable on a per-unit for the same throughput performance.

The delta really being the acceleration you get when you get hardware you can leverage the FPGAs.

So what we see when we do virtuals is we see large volume on the software side.

So usually there, you are discounting, your pricing is more aggressive, but you're picking it up in the volume.

So the per unit is identical.

If a customer was buying a single unit, there would be no delta in that pricing.

Got it.

Thank you.

Thank you.

Next question is from Mark Sue from RBC Capital Markets.

Sir, you may ask your question.

This is Spencer for Mark Sue.

Thanks for taking my question.

You talked a little bit about the CBC and traditional ABC part of the business is maturing, growing a bit while you're seeing good growth in security.

Have you already or are you going to, -- how quickly are you going to see the shift in spending, moving towards the investments in security and the growth in that area?

Our focus has always been on application delivery, and it continues to be on that.

What we are predominantly seeing is that application delivery in the early days, which started out around availability, has more to care about at the same token security, acceleration, and things of that nature.

So it's not as if we're positioning a standalone security appliance.

What we're positioning is really an application delivery device, where security is a key component of that, and that is the traditional shift.

Classically, a typical enterprise and/or service provider would be looking at purchasing two or three components or boxes to provide that service.

We've been consolidating that into a single fabric, so that is how we position into the market, so we're really capturing the consolidation play, as part of the security solution.

Great.

Thank you.

Thank you.

Next question is from Matt Robison from Wunderlich.

Sir, your line is open

Andy, can you comment on the CapEx of the facility upgrade?

Are we going to see that continue for very many quarters?

And then I was hoping you could derive a little bit more for us the $0.5 billion addressable marketing increase that's going to come with 12, and maybe comment on what's going on with diameter signaling.

Yes, so I think we will see -- you are right, a lot of what has driven our CapEx is investments we've made in our San Jose facility, where we expanded that facility and we put in a tech center in San Jose, so that we can bring customers in down there, in conjunction with our partners, all in the Bay Area.

So we think that's going to be really good.

We expanded Tel Aviv, we've been expanding in Seattle.

I think you will see one more big quarter next quarter, and then we will continue with expansion and upgrade in Seattle.

So to a lesser degree, you will see it continue.

It's all going to be good for hiring.

Karl, talk a little bit about Badger.

Just to parse out a little bit on the market growth, here.

About half of that growth we see coming from security, from the additional security products, specifically some of the DDoS and other capabilities we're adding to the product, as well as a portion coming from cloud, so cloud infrastructure, our VE, basically updating the VEs to run across different cloud environment, where I think Du Jour is actually part of the list, and there's a lot of things we're doing with auto scaling-out and other capabilities on that side.

A bunch of in service provider.

So being able to support the mobile core better, adding capabilities there to a number of functions, and also enhancing the carrier-class firewall, the SG firewall, components.

Okay.

Anything about diameter signaling?

I'm sorry.

On diameter signaling?

Is that the question?

Yes

Actually, in Badger, we're actually adding core to BIG-IP, new scalability for diameter signaling, and then we have some new opportunities on our traffic products, with regards to like what we call SRF, so basically it's managing subscribers, and we call it subscriber line management and some other things we're getting with Tier 1 carriers.

This is John Eldridge.

Excuse me for interrupting, but we would like to take two more questions, and then we will call it quits.

Thank you.

Next question is from Brent Bracelin from Pacific Crest Securities.

Sir, you may ask your question.

Two quick questions.

One for Manny, one for Andy, if I could.

Manny, first off, if I go back, it's been about four years since the version 11 was formally launched.

Coming out here with version 12, as you think about this release and what it means to F5, how important a release is it?

Is this really more a continuation of security, or is there something else we should think about relative to the release?

And then again, one follow-up for Andy.

Sure, Brian, I'll kick it off, and I'll turn it over to Karl, because four years ago, I still wasn't at the Company.

But in general, 12.0 is a great release and what it does for us.

I think what you are seeing from our portfolio where we have expanded.

Our vision is really all about hybrid, which expands beyond the traditional availability set of services, and we're moving to offer our services not only on-prem and also in a modernized SDN environment.

There is a lot of integration associated with that, where you continue to harden our product to make our product easy to work in modern SDN or data center environments.

But equally, how we run our services inside the cloud.

So what you're seeing is the platform expanding so that application services can be in all locations and any infrastructure, and that's the core to the part of 12.0.

Karl, do you want to add a little more color to that?

Just to add to that.

Badger's our largest release to date: 194 major features are being released with Badger.

And yes, we're doing a lot of work in security, obviously that's a big area for us, and we're adding capabilities across the board in security.

SSL is a big area that we focused a lot of attention, especially in areas of performance and adding new cyber suites and being able to address in applications.

But also, we've added a lot, just into the core of the product, being able to address protocols like HTTP 2.0.

And that's big, because customers are shifting to 2.0, because one, it's less costly for them to support it with their applications, and two, the performance is much better, and so we are supporting that.

Service provider: there's a number of areas that we are enhancing to support service provider functionality, including things with our firewall and our PEM modules and CGNet, just across the board, we're doing things to help enable core service provider, including NFV-based applications.

And also supporting cloud partners and being able to make -- we've made major enhancements to support VMware, Microsoft, Cisco and others, to make ourselves much more natively deployable into their environments.

And then there is other things that we've done within our hardware platforms.

We talk about our software-defined hardware.

Well, we have two new major functions that we're releasing to help support the significant increases in DNS performance, for example.

And also significant increases in security performance, being able to offload a lot more functionality into the hardware itself.

So there's a lot major functions across the board to address some of the things that Manny articulated on, when he was talking.

Helpful color, and then for Andy here real quickly, if I look at your guide for cash flow from ops for Q4, looks like you are on pace to grow cash 25% this year, 2X faster than revenue.

As you think philosophically about cash flow, do you expect cash flow to continue to be growing faster than revenue here, looking out into the next couple of years here?

Is that tied to mix shift to software or mix shift to subscription?

Just trying to get a little more color as you think about cash flow growing faster than revenue.

Yes.

To be honest, we really approach it so much more on profitability, and that's our focus.

I do think that as the Silverline services ramp up, that will drive cash flow more strongly, but we will see -- I don't -- I'm actually not really comfortable talking about guiding cash flow from that perspective.

But I've think the way you see us operate, focus on the top line growth, managing our profitability, staying on top of the business is something that we can plan to continue.

Okay.

Thanks.

Thank you.

Last question on queue (multiple speakers) is Subu Subrahmanyan from The Juda Group.

Sir, your line is open.

Thank you.

Two quick ones.

First, on product revenue growth, Andy if you could talk about the levers of -- given the growth you've seen on the software side.

How should we think about software versus hardware product revenue growth, and we're seeing hardware growth slow to the mid-single range, and you mentioned that as a priority, so how should we think about that going into next year?

And then on the telco side, you mentioned the move to NFV, being aggressive on that front, and I just wanted to see if -- how that changes the growth profile if it does at all, the ABC business on the telco side, understanding that a lot of the security stuff is incremental?

We don't break down the hardware-software revenue as we go forward, but what we are seeing is obviously because of smaller numbers, the software business is outpacing the hardware business from a growth perspective.

We don't think that -- there will be a little bit of a mix shift for an enterprise, from the perspective that maybe three years ago they were buying all hardware, but the enterprises we talked to or the service providers we talked to are not going 100% software.

They're really going, as I depicted earlier, to these two-tier architectures with a set of hardware services, that are -- they need to scale up really, meaning throughput, connections per second, things of that nature.

And the second tier of scale out services that are much more at the application environment.

So we actually think it's incremental.

Where we think also it's incremental is in cloud solutions.

Cloud solutions, when customers move application workloads to the cloud, predominantly, that's a software play.

There's a couple of cloud providers that have hardware options, but in general, it's a software play, so we think that is how it's going to mix.

Do you want to add to that, Karl?

Just add to the NFV comment.

What we are seeing from the operators, customers are looking for operational leverage.

So what they want to do is employ whatever software, whatever hardware they can, that reduces their operational costs.

Their problem is their budgets are scaling linearly, but their traffic is growing exponentially, and so they need a way to manage that.

And the way they're doing that is through automation.

And they want to be able to automate not only aspects of the applications, but their entire environment.

We play a key role in being able to bridge the applications to the environment and support that overall automation requirement, and so that's what they're looking at us to provide as part of NFV, in addition to being able to support whatever footprint they need, software versus hardware.

So you'll see the telcos, and I'll close on this is, the NFV movement is really management of the total cost of ownership for service providers.

And that's been predominantly because the cost, how they were monetizing their networks historically has been a throughput or a bandwidth type of connection.

The Internet traffic and the consumer is consuming those services faster than they can provide it.

So as a result of that, they have to go attack the network cost.

Scaling the network cost through the software, sometimes it's easier for them to do, and a lot more predictable.

So we're seeing that rapid movement by most of the telcos out there.

But don't confuse the fact that they are also going to have hardware.

They have hundreds of interfaces and above, and those interfaces have to be provisioned through hardware accessible technologies, so it's a mix that you're going to see, and it's a shift of pure hardware to hardware software.

If I just follow up on the product revenue point.

The product revenue growth this quarter at 5%.

Do you see that -- is it just some mix things that are impacting right now, or do you see them reaccelerating in line with overall growth?

How should we think about product revenue in the near term?

Yes, we are not going to talk about specific guidance on product revenue, except to say, again, it is our number one priority and that's what we're focused on doing, and how we are managing driving the business forward.

Thank you.

Okay.

Thank you again, all of you, for joining us on this call, and we hope you have a good quarter.

We will do our best to put up another good quarter, and we will talk to you again in three months or so.

Thank you.

Thank you.

That concludes today's conference, and thank you all for participating.

You may now disconnect.