F5 Inc (FFIV) 2016 Q4 法說會逐字稿

Good afternoon, and welcome to the F5 Networks fourth quarter and FY16 financial results conference call.

(Operator Instructions)

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

Sir, you may now begin.

Thank you, Vince, and welcome all of you on the line to our conference call for the fourth quarter and FY16.

John McAdam, President & CEO; and Andy Reinland, Executive Vice President & CFO; will be the speakers on today's call.

Other members of our exec team, including Ben Gibson, Chief Marketing Officer; and Ryan Kearney, Chief Technical Officer; are on hand to answer questions following their prepared comments.

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 at F5.com.

In addition, you can access an archived version of today's live webcast from the events page -- events calendar page of our website through January 25.

From 4:30 PM today until 5:00 PM Pacific time, October 27, you can also listen to a telephone replay at 866-479-8682 or 203-369-1542.

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 and 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 on our SEC filings.

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

Before we begin the call, I want to remind you that we are holding our 2016 analyst investor meeting at the Intercontinental Chicago Magnificent Mile Hotel on Thursday, November 17, from 8:00 AM until 12:30 PM.

If you plan to attend the meeting, you can register online from the link on our IR events calendar page for November 17.

For those who are not able to join us in person, the meeting will be webcast live and a replay of the webcast will be available through January 25, 2017.

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

Thank you, John.

F5 closed FY16 with a strong finish.

Both revenue and earnings for the fourth quarter of FY16 came in above our guidance as a result of solid year-over-year sales growth in the Americas, APAC, and Japan, and healthy demand for our existing products ahead of our appliance refresh that began rolling out in mid-September.

Revenue of $525.3 million was up 6% from the prior quarter, and 5% year-over-year, and above our guided range of $515 million to $525 million.

GAAP EPS was $1.64 per share above our guidance of $1.44 per share to $1.47 per share.

Non-GAAP EPS of $2.11 also exceeded our guidance of $1.92 per share to $1.95 per share.

Q4 product revenue of $253 million, up 9% from Q3 and down 2% from Q4 of last year, represented 48% of revenue.

Service revenue of $272.4 million increased 3% sequentially, 12% year-over-year, and accounted for 52% of revenue.

On a regional basis, America's revenue grew 5% year-over-year and represented 58% of total revenue.

EMEA revenue grew 4% year-over-year and accounted for 23% of overall revenue.

APAC revenue, which accounted for 14% of the total, increased 1% year-over-year; and Japan, at 4% of total revenue, was up 13% from a year ago.

During the quarter, enterprise customers represented 64% of total sales.

Service providers accounted for 18% and government sales were 18%, including 10% from US federal.

In Q4, we had three greater than 10% distributors: Westcon, which accounted for 18% of total revenue; Ingram Micro, which accounted for 15.2%; and Avnet at 12.5%.

Continuing down the income statement, GAAP gross margin in Q4 was 83.8%.

Non-GAAP gross margin was 85.2%.

GAAP operating expenses of $277.8 million were at the low end of our $276 million to $285 million guided range.

Non-GAAP operating expenses were $242.7 million.

Our GAAP operating margin in Q4 was 31%, and non-GAAP operating margin was 39%.

Our GAAP effective tax rate for the quarter was 33.1% and our non-GAAP effective tax rate was 31.9%.

Turning to the balance sheet.

In Q4, we generated $204 million in cash flow from operations, which contributed to cash and investments totaling $1.16 billion at year-end.

DSO was 46 days.

Capital expenditures for the quarter were $17.6 million.

Inventory at the end of the quarter was $34.1 million.

Deferred revenue increased 11% year-over-year to $870.2 million.

In Q4, we repurchased approximately 1.2 million shares of our common stock at an average price of $124.31 per share for a total of $150 million.

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

And in Q4, we increased our headcount by 70 employees to 4,395.

For the full year, revenue for FY16 was just under $2 billion, up 4% from FY15.

Product revenue of $944.5 million was down 5% from the prior year and accounted for 47% of total revenue.

Service revenue of $1.05 billion grew 13% during the year and represented 53% of the total.

GAAP net income for FY16 was $365.9 million or $5.38 per share, and non-GAAP net income was $496.2 million or $7.30 per share.

For all of FY16, cash flow from operations totaled $712 million.

Moving onto our guidance for Q1 and our FY17 outlook.

We are encouraged by increasing customer demand for all the new products we introduced in the second half of FY16, in particular for our new family of BIG-IP appliances, the Shuttle series, which we launched in September.

We expect to finish the rollout of these products in November and we anticipate a steady ramp in sales as they replace sales of our existing appliance family over the course of this year.

As we look to Q1, we expect to see the normal seasonality that accompanies the start of a new fiscal year.

In addition, we anticipate a continued challenging sales environment within EMEA over the short term, particularly in the UK, which we have also factored in when assessing our revenue expectations for Q1.

With that in mind, for the first quarter of FY17, we are targeting revenue in a range of $510 million to $520 million.

We expect GAAP gross margins at or around 83%, including approximately $5 million of stock-based compensation expense and $2.7 million in the amortization of purchased and tangible assets.

Non-GAAP gross margins are anticipated at or around 84.5%.

We estimate GAAP operating expense of $285 million to $294 million, including approximately $38 million of stock-based compensation expense, and $0.8 million in amortization of purchased and tangible assets.

We anticipate a GAAP effective tax rate of 33% for the quarter, and a non-GAAP effective tax rate of 31.5%.

Our Q1 GAAP earnings target is $1.40 to $1.43 per share.

Our non-GAAP earnings target is $1.92 to $1.95 per share.

We believe we will generate cash flow from operations at or around $200 million and we plan to increase our headcount by 60 to 80 employees during the quarter.

Looking out to the fiscal year ahead, our general planning assumptions and expectations are as follows.

From the base of Q1, we anticipate sequential revenue growth throughout the year with a strong second half of the fiscal year.

We anticipate that non-GAAP gross margins will remain in the 84% to 85% range.

We expect non-GAAP operating margins in the mid-30s range for the first half of the year and increasing to the upper-30s range for the second half.

Stock-based compensation is anticipated to be in the range of $175 million to $185 million for the year.

Capital expenditures are expected to range from $15 million to $20 million per quarter for ongoing infrastructure investments and facilities expansions.

Finally, we expect our effective tax rates to average approximately 32% to 34% on a GAAP basis and 31% to 33% on a non-GAAP basis for the year.

As John mentioned, our analyst investor meeting will be November 17 in Chicago.

We hope you can join us for this in-depth look at our business and our plans for FY17 and beyond.

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

Thanks, Andy, and good afternoon, everyone.

I will discuss the Q4 results in some detail and then outline the progress we have made during FY16 towards our goal of returning product revenue growth in FY17.

Overall, I was very pleased with the F5 team's fiscal Q4 performance, including record revenues of $525 million, record cash from operations up $204 million, and record profitability with 39% non-GAAP operating margin.

Many of the process systems and training investments that we made throughout the year in our go-to-market engine, together with a significant addition of new sales and marketing leadership talent, began to bear fruit in fiscal Q4.

I am especially encouraged by the improvement in sales and execution last quarter from the Americas region, which returned to year-over-year sales growth for the first time in several quarters.

I view this as a significant milestone in our path to delivering consistent product revenue growth.

I was also happy with the results of our Japan and our Asia-Pacific regions, which both delivered year-over-year sales bookings growth for the quarter and the entire fiscal year.

Sales bookings in EMEA, however, were again down year-over-year, driven by weak sales in the UK.

Once again, our services business delivered strong results and excellent profitability with year-over-year revenue growth of 12%.

As well as providing world-class customer satisfaction, our service business has been crucial to our profitability throughout FY16.

We believe that there are several emerging market conditions that have increased the appeal of our products with enterprise and service provider customers in Q4.

Firstly, customers are increasingly leveraging our products, not only for native security features, but also for the ability of our products to orchestrate and intercept SSL traffic laws.

Hackers today are more often leveraging SSL traffic for malware delivery, thereby making the F5 SSL orchestration and inspection capabilities more and more relevant.

For example, a $5 billion healthcare organization deployed F5's iHealth application and in so doing, determined that 93% of its data center traffic was encrypted and that its existing perimeter firewalls were being defeated by a flood of malicious and non-malicious traffic.

The ultimate resolution included deploying an F5 VE-based SSL solution, working in tandem with a Cisco Firepower intrusion prevention offering.

This collaborative SSL orchestration solution was repeated more than a dozen times this quarter in several large global enterprises.

Similarly, we experienced real traction with our anti-fraud WebSafe platforms in Q4.

We believe this reflects both the increasing sophistication of bad actors focused on credential theft as well as the explosion of SSL traffic in the transport of email and other enterprise and public messaging applications.

Our WebSafe product is very effective over SSL encrypted traffic, giving F5 very strong competitive differentiation with these solutions.

We had a large win in Q4 with an Australian bank who leveraged our WebSafe and mobile safe anti-fraud capabilities to facilitate the protection of 10 million domestic and international banking customers.

The F5 solution provides a clientless private cloud capability to the bank, which uniquely met the requirements of the ever-growing mobile banking clientele.

A second emerging trend is the growth opportunity we are experiencing with customers provisioning our proxy-based security solutions to deploy a consistent security stack, and security policies across on-premise, off-premise, and public cloud infrastructures such as AWS and Microsoft Azure.

A multi-national airline was suffering from brute force attacks against its web-based and private cloud assets.

This customer leveraged a combination of our ASM WAF and Silverline WAF as service offerings to mitigate unwanted package totems and help them meet end-customer service delivery expectations.

This solution provided a set of IT administration abilities across its hybrid public and private cloud environment, thus reducing management complexity and total cost of ownership.

Similarly, two different banks in our Asia-Pacific theater deployed BIG-IP ASM modules within the AWS environment to facilitate a public cloud migration of several customer facing Internet banking sites.

Our solution allowed both banks to duplicate both their ASM functionality and their home-built library of iRules that they had optimized on their own premise data center for use in the public cloud.

As we gain more and more experience of customers using F5 solutions to move their apps and what goes to public and private cloud architectures, we are convinced that this is yet a third market trend with significant opportunities for F5.

Within our existing customers -- I'm sorry -- When our exiting customers initiate lift and shift programs to move applications to the public cloud, they continue to view rich F5 ADC functionality such as programmability via iRules as critical for application optimization and application security.

For example, an international provider of chassis-based workflow automation solutions leveraged our virtual edition traffic management capabilities in the AWS environment to activate remote instances of the product in Canada, Australia, and the United Kingdom.

Working together, AWS and F5 helped the customer emulate the traffic management protocols and reuse the on-premise configuration details we had optimized and hardened over time.

The resulting solution greatly reduced the latency that the international customers had been experiencing when accessing the application remotely.

This trend was thoroughly enforced when a US-based provider of entertainment, media, and streaming content deployed a ADC solution in the Amazon Web services environment.

Our cloud-based solution allowed for rapid activation of additional streaming sessions during on-demand-style broadcasts, when subscriber demand significantly exceeded expectations.

The content for these events is primarily delivered by the customer's private cloud.

However, this joint F5 and AWS solution provided for a standby capacity, leveraging a hybrid cloud architecture.

From a product perspective, we delivered on our goal to commence shipments of a new range of appliances in Q4.

This new product lineup, known internally as the Shuttle series, is perhaps the most comprehensive range of new products we have delivered to the market.

We started shipping the high-end products in the final weeks of the quarter and we expect to have the entire product range available by the end of November.

As I have mentioned before, the Shuttle series is more than a simple product line upgrade.

We believe that the Shuttle series is the world's most programmable, cloud-ready ADC.

The Shuttle series provides the agility that DevOps organizations demand, together with the scale, security, and investment protection that our traditional customers have long enjoyed.

On our quarterly conference call last January, when we announced our Q1 results, I gave a high level view of the significant array of new products we had on our roadmap for delivery in FY16.

The Shuttle series capped a tremendous year of product introductions in FY16, which will provide solid business drivers in the current fiscal year, enabling the F5 team to achieve our goal of delivering product revenue growth throughout the year.

We saw very good traction and sales of our new 100 gig blade last quarter, and it was exciting to see a significant number of these sales taking advantage of the 100 gig blade's world-class performance to enhance solutions like the Gi firewall.

Security, Gi lan consolidation, NFV solutions, traffic speeding, and TCP optimization continue to be successful areas of focus for F5 in the service provider market.

Our vast array of new products including the Shuttle series, the SSL Orchestrator, the DDoS defender, mobile series, iApps LX, BIG-IQ, and our iWorkflow orchestration engine, as well as our upcoming TMOS 13.0 release, all further support our efforts to enable our customers to officially migrate their apps to private and public cloud architectures.

As far as FY17 Q1 outlook is concerned, Andy discussed our high-level financial views for FY17 and indicated that we expect to deliver revenue in the range of $510 million to $520 million in the first quarter.

I believe that F5 is very well positioned moving into FY17 to take advantage of the new products and business drivers as well as the new opportunities, including the explosion of SSL encrypted traffic.

Customers' requirements to have consistent security policies across on-premise and public clouds and the move of application workflows to private and public cloud architectures.

We will be presenting our strategy in detail at the November analyst investor conference.

We have a lot to cover that day including details on our strategy and roadmap on several topics.

For example, we will present our plans and progress on DevOps-centric architectures, including containerized microservices, OpenStack, orchestration, and visibility and analytics.

I look forward to seeing you at the event.

In conclusion, I would like to thank the entire F5 team, our partners and customers both, for the support last quarter and with that, we will now hand the call over for Q&A.

(Operator instructions)

Tim Long, BMO Capital Markets.

Thank you.

Just two, if I could.

First, if we could just touch on Europe.

It sounds like you have had some really good sales execution in the US market.

Anything that can be done differently in Europe or is it just really too much macro that is going on there that might make that a little bit more challenging?

Secondly, could you just update us on how trends for standalone security products and the software offerings trended in the quarter and the outlook for into next fiscal year?

Thank you.

Okay.

On EMEA first of all, and I talk about EMEA, not just Europe because that is where the organization is.

First of all, we have had strong management in EMEA for a long time and they actually had an excellent FY15.

Definitely, 2016 was problematic in some areas.

I really believe that macro was definitely involved in the UK issue.

One of the things that is probably unique to F5 more than a lot of other companies is that if you look at our major occurrence regions, the financial vector is very, very important in that region.

Frankly, that was a tough market after the Brexit announcement.

They seem to be taking some time to make up their mind as to where they are going to deploy their money moving forward.

Having said that, you always look at execution and we continue to do that.

I think it was more macro.

In terms of the standalone products, I mean, SSL, you heard me talking about SSL and orchestration and Intercept, and also DDoS, I mean, they were the first two solutions that we came out with.

We feel very good about the trajectory of that solution base.

We are going to be talking a lot more about this in November and you will hear us talking about product additions in that area.

I don't want to get into it right now.

It is not appropriate, but you will hear us talking about that.

That I think will increase the opportunity in 2017 and also more functionality as well.

We think that because of our SSL expertise, we are really, really well positioned to take the opportunity.

Ryan, do you want to mention anything about service training and how it's a unique capability for us?

Sure.

Just to reiterate also, some of the programmability and orchestration capabilities of our product, actually, from a historical perspective, have really lended itself very well to new environments like NFV and service training, etc.

We have a tremendous amount of good response, especially through the quarter with some of those solutions and we will continue to.

One of the things that I mentioned that may have gotten missed actually, was when I talked about one of the examples that use the Cisco Intrusion Prevention product, and then there was a sentence after that talking about, we have done a number of these collaborative type solutions.

I am talking about working with companies like FireEye and Palo Alto where we can make those SSL transactions visible to those types of solutions.

Okay.

Thank you.

Rod Hall, JPMorgan.

Yes, hi, guys.

Thanks for taking my question.

I guess I had a quick technology question and then maybe a question on the numbers looking into 2017.

On the tech question, Ryan, there is a lot of people are looking at some of these virtualized ADC guys and they really like the fact that the software has a very small footprint, it's virtualizeable, and you guys, I know, have talked about this from time to time, but I just wonder if you could update us on where you are with shrinking the footprint of the software so that it really lends itself to a virtualized environment and automated environment for spinning up new instances of the ADC and so on?

If you could just talk about that and then I will just follow up after you answer with the financial question.

Yes.

Absolutely.

The footprint of software and virtualized ADC functionality is it's very important actually to be smaller, more agile, more flexible in these new cloud environments, both public and private cloud.

We put a significant amount of investment into this actually over the last few quarters and we will continue to do so actually.

Including smaller versions within Amazon, smaller versions actually helping us increase the density of these solutions within hardware platforms and stuff like that.

It is also not just a smaller footprint, but it is faster boot times.

It is easier licensing.

It is more service level API's for programmability net orchestration.

So in general, getting lighter, faster is definitely part of it, but fitting into these new orchestration environments and increasing capacity and density is also critical.

It is a big focus area.

And I'm probably going to say it 10 times on the call, but again, we will be giving this in much more detail in November, but yes, it's smaller.

You will hear us talking about microservices, elastic ADC, there are a lot of things coming there that are very, very cloud friendly.

Okay.

As usual, we don't have enough patience I guess.

(laughter)

And then the operate -- you guys talk about the mid-30s operating margin in the first half of next year and then high 30s for the end of next year.

Can you walk us through, it looks to us like you probably do high 30s in the first part of the year.

What is going on with OpEx there?

Are you planning to -- can you walk us through the trajectory of OpEx through the year so we make sure that we are thinking right on the models?

Yes.

Actually, if you look at the last couple of years, we have given this same sort of guidance rolling into the new fiscal year where we have said look, we see seasonality in Q1 sometimes rolling into Q2 and then we strengthen in the back half.

Historically, when we have tried to maintain operating margin at too consistent of a level throughout the year, it's hurt us when our primary investment vehicle is headcount.

We slow things way down and then try to catch it up again.

I think it was started in FY14, we went to the mid-30s in the first half to allow us to keep investing and then drive strength through the back half on the back of strong revenue.

That is what we are laying out again for execution for this year.

Okay.

So we just see normal seasonality on the OpEx as we move through the year then?

Yes.

Exactly.

All right.

Thank you, guys.

Thank you.

Pierre Ferragu with Bernstein.

Thank you for taking my question.

Could you give us a bit more details on how your business is picking up on the cloud like your virtual editions of offshore products?

My question would be first, how big is that today for you, and how fast is it growing?

And then my second question is, how much of your business in the cloud is really new business coming from new clients and the cloud is for you actually almost like a new distribution channel that allows you to address a market that you were not addressing that much before, and how much of that is more like your existing clients using F5 on their own infrastructure and willing to keep a very similar framework when they go to the cloud?

Right.

This is John.

That is a pretty broad question in terms of the different areas.

The answer is going to be all of the above in a lot of the questions you talked about.

First of all, when we talked about the three emerging things that are happening that we are excited about, one obviously being SSL.

The other two are very related to the cloud, where, one being we are seeing customers have this absolute need to have these constant security policies and processes throughout a hybrid cloud, or a public cloud, or a private, non-premise environment.

That is a big opportunity for us.

Then, there is the classic lift and shift capability that we have seen where we have seen a very, very, very, almost 100% success rate, where customers lift and shift -- customers -- lift and shift our solutions or apps and move them over when they want to use a security products or they want to use iRules.

Again, we think that is a big opportunity and we are going to be partnering with Azure and AWS for those types of opportunities.

I'm not going to be specific on numbers.

We have also seen examples where, for example, our WAF that we proved with on the Azure cloud, it's a complete new business opportunity where we did not net a customer at all.

So we have seen that as well.

I think that is covering most of what you asked.

It was a pretty broad question.

Generally, we feel quite good now that this whole move, this trend is an opportunity for us because of the richness of our software and our security portfolio and our application optimization portfolio.

And the cloud is like a new channel, allowing you to address clients you are not addressing before.

That's right, and I gave -- one of the examples I'll give you is a customer that we did not know, we had not been selling to, buying our WAF solution off Azure.

Okay.

I get it.

Going forward, one of the things we're going to be doing is increasing our inside sales organization to basically focus on Silverline and doing more sales that way.

By the way, a lot of that is new business when we see those customers.

But also, not just Silverline, focus on AWS's marketplace as well as Azure as channels.

Thank you.

Troy Jensen, Piper Jaffray.

Congrats on the nice results, gentlemen.

Thanks Troy.

So Andy, maybe for you first here, gross margins ticked up nicely this quarter.

I am assuming that had a lot to do with software.

Can you just touch on that?

Then if you do product introductions, do expect them to be above or below the corporate margin average?

Yes.

So, when you look at our margin profile, the gross margin, it was really driven by services and on a couple of fronts.

One, we are seeing higher gross margins from our consulting business.

Efficiency is just overall, with technology that we are using for just higher productivity, call avoidance, those types of things.

Then, our hiring was a little behind which drove it up as well.

Gross margin on the product side was actually pretty consistent quarter over quarter.

In our guidance, you see that we pulled it back a little bit.

That is because we will probably catch up on the hiring side as we dive through Q1.

Then, in terms of the profile as it relates to the new product introductions, they are going to be pretty consistent.

We are still in the position that we are able to price to margin and we do that in driving value, and we see that in the consistency in the product margin we have seen for really years.

All right.

And then maybe just a follow-up for you, a two-part one.

Government business was at a record level with respect to revenues and percentage of sales.

Just curious to know what drove that.

And then the service credit downtick, it looks like it is a seasonal number but what is your confidence on service provider vertical?

On the federal business, what we are seeing is bigger and bigger type sales.

Multimillion dollar sales are pretty common now and just a big opportunity there, security of course.

It is pretty important there.

It is really I would call it an evolution rather than a revolution type of increase in the business.

And just on service provider, John?

I missed the question.

Sorry.

It was down sequentially.

It looked like that's seasonal, so the question was, just kind of your conviction on the service provider vertical.

Right, from a revenue perspective, actually sales wise, it was pretty solid.

The sales, in other words, it was some systems not shipped.

The hundred gig feel very good about that, very good.

Not just the sales that we made, but we are being used like in the Gi firewall, and then more importantly, on the pipeline.

We feel very good about that.

NFV, I think we are incredibly well positioned for NFV because of our software portfolio.

And of course we are still working on increasing the throughput to 40 gigs and outwards on our VE solution and I think that's ideal for NFV.

All right.

Keep up the good work, gentlemen.

Thank you.

Ryan Hutchinson, Guggenheim.

Good afternoon, guys.

I got a question, as I think about the product cycle here, product revenue is down about 5% last year and this is the most comprehensive product refresh you have had in some time.

I don't know if it is bigger than Buffalo Jump, maybe you can comment on that.

I guess what I'm looking for, maybe talking through, as we think about this, the installed base and you've touched on it in the past.

Just to refresh us, the number of units up for refresh, how ASP's and deal sizes have trended relative to historicals.

Any sort of input that we can take to consider and get comfortable that you can indeed grow product revenue this year?

And then, why wouldn't -- I guess the follow-up to that is, you're six months into this refresh -- or, six weeks into this refresh.

Any sort of color around how things are tracking relative to historical refreshes?

Thanks.

I am glad you said that.

Right at the very end you said, six weeks.

That is about right actually, in the sense that we only started shipping the product, the high-end portion of the Shuttle series towards the end of the quarter.

It is probably five or six weeks.

We have clearly seen good traction already.

By the way, in the first -- it's only recently, in the last week or so that we have been training the sales force in this and allowing them to actually push it, but we've taken orders in any event.

We are happy with the traction.

We have seen -- remember, it is a high-end product (inaudible).

The rest of the product line we expect to be done by the end of November.

There is just a lot of good reasons for it to be successful.

The customer base, as you asked about, more than five years is over 40,000.

I think it's about 42,500; 44,000 I should say.

That is bigger than it has ever been in a product refresh before.

We have got massive amount of systems available now to the sales force to highlight where these customers are, when their service contracts are up, et cetera.

They have a lot of ammunition to be able to execute on that refresh.

I just think, was there any other questions?

I think that answered the question.

Just on that installed base, you said 44,000.

How does that compare when you look at metrics and analyze it on the backside?

How does that compare relative to some of the prior?

I think we said last quarter that, Cooper, wasn't it --

It was higher than, it was something more than 60% greater than on our last product cycle.

Like 63% or 65% higher than our last product cycle.

Did you hear that?

About 65% higher than the last product refresh.

Okay.

Okay.

Thank you.

Tal Liani, Bank of America.

Hi, guys.

I looked at my notes from last quarter and there seemed to be great improvements on certain areas.

I want to focus maybe on the North American part.

In your prepared remarks, you said that the North America improved.

I am trying to understand where did the improvement come from?

Last quarter, you reported the hesitancy to close some deals and push out and migration to cloud is negative.

In this quarter, we see the opposite.

I am trying to understand if it is an issue of products, maybe something that you have done to your sales organization that you call it execution, and anything else that contributed, maybe spending cycles or anything else that contributed to this improvement in North America.

If you can discuss the factors.

Yes.

Sales improved fairly significantly quarter-on-quarter.

Sales, I am not just specifically talking revenue.

And those sales were orders that some shipped in the quarter and some didn't.

But sales increased.

A lot of that was execution.

I talked about, at the beginning of my script, that to the sales leadership that John DiLullo has brought into the Company, including America salesperson, as well as some real channel expertise.

We have added a whole lot of new processes.

One thing you said that I want to be very clear about, we did not say last quarter that we thought the cloud was a headwind.

We actually talked about a lot of customer examples showing the opposite where it was a tailwind.

What we have seen is that tailwind getting stronger in Q4.

And when you look at the cloud, how does the business model change for existing customers?

Meaning, if today you charged certain price on the product and then you had maintenance revenues, what happens when you migrate to the cloud for the same customer?

(multiple speakers)

That is a complicated question in the sense that it depends on the architecture the customer goes for.

For example, if a customer -- a customer may move applications that don't have an ADC in front of them.

That is an opportunity for us.

A customer, when he moves applications to, say, a public cloud, may want to do more horizontal scaling because it is a software type shift.

That is an opportunity.

In fact, we've talked about that before where when we see the VE type solutions, we tend to see as much revenue because it is not of ethical scalability as horizontal.

In other words, instead of a Viprion sitting in front of a hundred apps, you have one app -- one image of VE per app.

It is quite a complicated scenario, but we feel good about it.

Everything we have seen tells us it's an opportunity.

Another thing we can talk about when we do that is adding security.

Security when you move to the cloud is critical.

The chances of us adding more functionality from a module perspective is also good.

Got it.

Just last follow-up.

Any update on new CEO?

You said in the past about, it will take you three to six months.

I think we are coming to the six-month anniversary.

Any update?

Yes.

We started the process, Tal, in July, toward the end of July actually.

We're not really at the end.

We have got the search committee from the Board, specific search committee of Board members working on this.

We have actually done some interviews.

The search committee and the team are being very, very thorough about this.

There is no timescale yet.

There are no timescales associated with it.

The main focus of the team in this room is on the business.

Thank you.

Thank you.

Catharine Trebnick, Dougherty and Company.

Good afternoon and thanks for taking my question.

Could you give us some more detail on how you are doing with the service provider segment in the different regions and what would be -- you did talk about the hundred gig blade.

What are some of the other use case applications that are more popular with F5 today as opposed to maybe a year or two years ago when we thought a lot of the activity would come from the diameter?

Thanks.

Yes.

Definitely.

There are two big areas that we view and if anyone wants to chip in, that is fine.

Basically, on the one hand, we have NFV and that moved there and a whole range of software and orchestration and management that we brought to the market in FY16 that helped that dramatically.

And we talked about speeding up the VE performance as well.

That is one hand.

On the other hand, we have the Gi lan, and the Gi lan, you've got the Gi firewall, you get traffic steering, CG net, and that's a consolidation play.

It is a big consolidation play there.

The other thing to think about is obviously the stuff we are talking about in the cloud applies to the service provider space and so does SSL.

The increase of SSL traffic is also a big opportunity in service provider.

Okay.

One follow-on question.

Last Friday, we had this huge DDoS attack domestically.

Can you talk to whatever you can on how well your DDoS product is doing?

Thanks.

Yes.

We have had some really, really powerful examples of -- I am obviously not going to name customers here -- of mitigating very large DDoS attacks and have done it pretty successfully.

Obviously we have an on-premise DDoS capability, but I'm really talking about Silverline for the really big attacks.

Over time, we are going to introduce signaling in DDoS which I think will be incredibly powerful.

That allows us to, if we see some sort of signature type thing happening on an on-premise solution, where we know the size of an assault base and then we can actually upload that to our Silverline as a service solution and other customers get access to it.

I think that is incredibly powerful.

We have done extremely well.

I can't go through the details in terms of the gigs, but it was as high as you have seen in some of the more public examples.

All right.

Thank you very much.

Alex Kurtz, Pacific Crest Securities.

Hey, guys.

I had a question about the refresh and the opportunity around the security bundling.

John, are you looking to introduce any kind of special programs to see if you can increase your security dollars as you refresh some of your core ADC and cell-based customers?

This is Ben Gibson on this one.

We are definitely looking to both continue the good, better, best smart bundling initiative that we have had in place.

We see a good opportunity to expand on that in a few differed areas.

I think the key is not only for security attached to integrated ADC system, but also the opportunity through the next few quarters to attack new buyers and budgets.

It is not only security attacks in terms of products, but what I think is really interesting in the coming year is security attached to new security buyer and budgets within same account.

As the portfolio continues to expand on that front, we think there is some interesting opportunities there.

Thanks.

Vince, we are going to take two more calls and then wrap it up.

George Notter, Jefferies.

Thanks a lot.

I wanted to follow-up on the product refresh questions.

I think if we go back a few months ago, there were some open questions about whether or not you would see a wait-for effect from customers, kind of holding off for the new product delivery.

I am wondering if you have indeed seen any of that or expect to see any of that in the December quarter?

And then also I wanted to ask about evidence of customers trading down.

Obviously, the refresh gives customers access to products that have significantly more performance at similar types of prices, I guess I am wondering if people are looking to trade down.

Thanks.

On the Osborne question, the delay question, first of all, you have to say sometimes you don't see this.

Sometimes you don't see it.

I don't think we had any material slowdown last quarter.

I don't think we saw that.

We didn't actually start shipping until the end.

So in fact, the new products were pretty immaterial to the results last quarter.

We expect them to be more material this quarter.

In terms of this quarter and delay, there is no signs of that yet.

I think we do a lot of mitigating to make sure.

We watch it like a hawk in December because December is obviously when we have the whole product range announced.

I think we have that money reasonably well.

We will see what happens there.

The other thing is, from a trading down perspective, interest of note, this is dangerous me saying this because there's not much data because it is only a few weeks we have been shipping the product, but we have actually seen quite a high interest at the very high-end model right now.

That is probably going to change when we have the whole range available, but that is we've seen so far.

Got it.

Just a follow-up on the Osborne effect idea.

Are you guys modeling for any of that in the December quarter in that guide?

Yes.

We always assume that type of -- yes is the answer.

The other thing I am just thinking about on it is that one of the things that is very, very -- a big increase that we have got from a performance perspective with this new product refresh is SSL.

They had me going on and on about SSL and I know the field are very excited about it, but we are going to bring more performance with shuffle there.

That could mitigate any Osborne effect as well.

Also, it is going to be the first ADC with ECC decryption -- encryption available.

We are going to have quite a competitive advantage as well.

Great.

Thanks.

Thanks.

Jim Suva, Citi.

Thank you so much for the detail so far on the conference call.

I have one question and clarification question.

If you look ahead on your guidance, which is quite encouraging, is it fair to assume that we are now turning the corner, that your product growth year over year with all your launches and comps will turn positive?

Or is there any type of variability I should think about as we kind of look ahead?

It appears that we would now be at a point where turning positive products growth year over year.

And then the clarification question is, have you had any component shortages or any gating factors that we should be mindful of, that would either A, impact shipping times, or B, potentially margins or costs on your side?

Thank you.

Yes.

Regarding the product revenue goal, I think you can go back and look at why I said in my opening remarks is our goal is to be, just to have product revenue growth throughout the year.

I did not say that in January.

I can assure you.

Yes, I think there is improvement there.

In terms of the product shortage, Julian?

This is Julian.

There's new product introduction and you are using some old suppliers and some new ones.

We have not seen anything abnormal to the normal ebbs and flows that you would see within the supply chain.

Great.

Thank you so much for the clarification and details.

Thank you.

Thank you all for joining us and we hope to see many of you at our analyst day in Chicago on November 17.

We will talk to you next quarter.

Thanks a lot.

Thank you.

That concludes today's conference call.

Thank you all for participating.