F5 Inc (FFIV) 2017 Q4 法說會逐字稿

Good afternoon, and welcome to the F5 Networks Fourth Quarter and Fiscal 2017 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. Jason Willey, Director of Investor Relations.

Sir, you may begin.

Thank you, and good afternoon, everyone.

As Lawrence said, I am Jason Willey, F5's Director of Investor Relations.

François Locoh-Donou, President and CEO of F5; and Andy Reinland, Executive VP and CFO, will be the speakers on today's call.

Other members of F5's executive team are also on hand to answer questions following the prepared remarks.

If you have any questions after the call, please direct them to me at (206) 272-7908 or j.willey@f5.com.

A copy of today's press release is available on our website at www.f5.com.

In addition, you can access an archived version of today's call from our website through January 24, 2018.

You can also listen to a telephone replay at (888) 566-0574 or (402) 998-0680.

In 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 on 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.

Before we begin the call, we wanted to announce that we will plan -- that we plan to hold our 2018 analyst investor meeting in New York on Thursday, March 8. More information on the meeting will be available shortly on our Investor Relations' Events web page.

I will now turn the call over to Andy.

Thank you, Jason.

We ended our fiscal 2017 on a solid note with record revenue and earnings for the fourth quarter, with solid growth in our virtual ADC offerings, particularly in public cloud environments, and continued strength in sales of our security offerings.

Fourth quarter revenue of $538 million, up 4% from the prior quarter and 2% year-over-year, was above the midpoint of our guided range of $530 million to $540 million.

GAAP EPS of $2.14 per share was well above our guidance of $1.64 to $1.67 per share.

Non-GAAP EPS of $2.44 per share was also above our guidance of $2.20 to $2.23 per share.

I will discuss these strong EPS results in more detail later in my comments.

Product revenue of $249 million in the fourth quarter was down 2% year-over-year and accounted for 46% of total revenue.

Service revenue of $289 million grew 6% year-over-year and represented 54% of total revenue.

On a regional basis, Americas revenue grew 1% year-over-year and represented 58% of total revenue.

EMEA revenue grew 7% year-over-year and accounted for 24% 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 also up 1% from a year ago.

Sales to enterprise customers represented 64% of total sales during the quarter.

Service providers accounted for 19% and government sales were 16%, including 7% from U.S. federal.

In Q4, we had 4 greater than 10% distributors: Westcon, which accounted for 15% of total revenue; Ingram Micro, which accounted for 15%; Tech Data, which accounted for 13%; and Arrow at 10%.

Moving on to our operating results.

GAAP gross margin in Q4 was 83.2%.

Non-GAAP gross margin was 84.5%.

In Q4, we undertook a comprehensive business review and analysis of our strategy.

Through this process, we took measures to better align resources around our strategy for growth.

In particular, we will be accelerating investment in our road map and route-to-market efforts in the fastest growing areas of our business, cloud and security.

As a result, we took a $12.7 million restructuring charge that is reflected in our GAAP OpEx results.

GAAP operating expenses of $299 million were above our $283 million to $293 million guided range as a result of the restructuring charge.

Non-GAAP operating expenses were $248 million, in line with expectations.

Our GAAP operating margin in Q4 was 27.7%.

Our non-GAAP operating margin was 38.4%.

Our GAAP effective tax rate for the quarter was 11.8% and our non-GAAP effective tax rate was 26.8%.

During the quarter, the company repatriated $86 million of cash to the U.S. As a result, the company was able to utilize accumulated foreign tax credits, which resulted in a onetime GAAP tax and EPS benefit of $21 million.

We view this gain as a onetime occurrence resulting from proactive initiatives associated with executing our ongoing tax planning strategy.

Both GAAP and non-GAAP effective tax rates also benefited from year-end adjustments related to our mix of profits recorded in lower tax rate jurisdictions.

Turning to the balance sheet.

In Q4, we generated a record $213 million in cash flow from operations, which contributed to cash and investments in totaling $1.3 billion at year-end.

DSO at the end of the quarter was 49 days.

Capital expenditures for the quarter were $7.5 million.

Inventory at the end of the quarter was $30 million.

[Deferred] revenue increased 11% year-over-year to $964 million.

We ended the quarter with approximately 4,365 employees, down 150 from the prior quarter.

In Q4, we repurchased approximately 1.26 million shares of our common stock at an average price of $119.06 per share for a total of $150 million.

After the end of the quarter, the Board of Directors authorized an additional $1 billion for the company share repurchase program.

For all of fiscal 2017, revenue was $2.1 billion, up 5% from fiscal year '16.

Product revenue of $965 million grew 2% from the prior year and accounted for 46% of total revenue.

Service revenue of $1.1 billion grew 7% during the year and represented 54% of the total.

GAAP net income for fiscal year '17 was $421 million or $6.50 per share and non-GAAP net income was $543 million or $8.38 per share.

For fiscal year '17, cash flow from operations totaled a record $740 million and capital expenditures were $39 million.

Moving to our guidance for Q1.

We remain confident in our position in the market and growth opportunities for the business with solid momentum in the cloud and security space.

While we see continued impact on near-term spend by customers evaluating their application architectures, the long-term trend toward multi-cloud environments is a strong and fundamental growth driver for our solutions.

With this in mind, as well as factoring in our normal seasonality, for the first quarter of fiscal year '18, we are targeting revenue in a range of $515 million to $525 million.

We expect GAAP gross margins at or around 83%, including approximately $5.5 million of stock-based compensation expense and $2 million in the amortization of purchased intangible assets.

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

We estimate GAAP operating expenses of $288 million to $298 million, including approximately $38 million of stock-based compensation expense and $0.8 million in amortization of purchased intangible assets.

We anticipate a GAAP effective tax rate of 33% for the quarter and a non-GAAP effective tax rate of 31%.

Our Q1 GAAP earnings target is $1.47 to $1.50 per share.

Our non-GAAP earnings target is $2.02 to $2.05 per share.

Finally, as has been our practice, we want to provide you with broad modeling assumptions for the fiscal year.

For fiscal year '18, from the base of Q1, we anticipate sequential revenue growth throughout the year.

We anticipate non-GAAP gross margins in the 84% to 85% range for the year.

We expect non-GAAP operating margins in the mid-30s range for the first half of the year and increasing through 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 $8 million to $10 million per quarter for ongoing infrastructure investments and smaller facilities projects.

In addition to these costs, we anticipate approximately $30 million to $40 million in CapEx costs related to our previously announced move of our corporate headquarters to F5 Tower in downtown Seattle, as we ready the space for occupancy in calendar 2019.

We expect our effective tax rates to average approximately 32% to 34% on a GAAP basis and 30% to 32% on a non-GAAP basis for the year.

These effective tax rates do not factor in potential impact from federal tax reform initiatives.

As Jason mentioned, we will host our analyst investor meeting on March 8 in New York.

With that, I will turn the call over to François.

Thank you, Andy, and good afternoon, everyone.

We ended fiscal 2017 by delivering record revenue non-GAAP EPS and operating cash flow for the quarter and the full year.

During the fourth quarter, we saw strong momentum in our virtual edition and advanced application security offerings and solid performance in our Services business.

We are excited by increasing customer interest in our software-based solutions, and we expect this area of the business to be a key long-term growth driver.

In Q4, we undertook a comprehensive business review with the goal of examining both the near and long-term strategy for the company.

The process solidified our belief in the long-term growth opportunity within our core application services market, enabled by the growing importance of application security and emerging consumption models for ADC technologies.

We see customers increasingly adopting a multi-cloud strategy with a wide range of applications hosted across on-premise, private, colocated and public cloud infrastructure.

This multi-cloud world allows customers to more easily develop and deploy applications, but it also brings new challenges in application delivery and security to the forefront.

We are confident that our breadth of application knowledge and our depth of product capabilities position us to be the key partner in helping customers solve these growing complexities.

Commitment to this strategy is already evident in the solution offerings we are bringing to market, which are focused on more flexible purchasing models for virtual editions and making our offerings more lightweight, more scalable and easier to manage.

In the planning process for our fiscal 2018 year, we prioritized R&D and go-to-market resources the key focus areas of cloud enablement and application security.

We are also in the process of strengthening our senior leadership team around these competencies.

As we move forward, we expect to invest aggressively in hiring and resourcing high priority areas while ensuring that we manage our operating expense levels to continue the company's track record of delivering strong profitability.

We look forward to sharing more detail on our long-term strategy and introducing several new additions to the F5 leadership team at our analysts meeting on March 8.

Taking a closer look at fourth quarter results.

Revenue was above the midpoint of our guided range, and we saw strength in our software offerings including virtual editions and security modules, and in solutions for the service provider vertical.

Our Services business delivered another solid quarter in Q4 with key business metrics, including renewal rates, attach rates and pricing in line with historical trends.

In the fourth quarter, we saw several meaningful examples of customers moving forward with projects that have been on hold as they evaluated their application architectures.

We saw a local technology company that had been delaying purchases as they evaluated a cloud-only strategy move forward with our solutions in a [hybrid] deployment approach as they realized not all their applications were best supported by a public cloud environment.

In another example, after an extended evaluation of various cloud options, a large financial services customer moved forward with F5 solutions, in conjunction with Equinix and a public cloud provider.

This decision was driven by our ability to allow the customer to replicate their security posture across a multi-cloud environment.

In the fourth quarter, we saw continued momentum from our Web Application Firewall offerings.

We closed a deal with a major U.S. credit union consisting of appliance, software and professional services solutions that was driven by the capabilities of our WAF offering to address specific threat requirements.

During the quarter, we received a strong third-party validation of our leading WAF solutions.

Industry analyst firm Gartner placed our WAF offerings in the leader section of their Magic Quadrant.

As part of a more focused security strategy, we see WAF playing an increasingly important role as more customers realize the need to deploy this layer of protection in front of an increasingly large number of applications.

This sentiment was echoed to me in a conversation I had with a large European bank where their internal policies are migrating to require a WAF in front of all applications.

We also have strong results from our Advanced Firewall Manager, where we see growing interest from mobile and fixed line service providers.

In the fourth quarter, we saw meaningful follow-on orders from a leading U.S. mobile operator looking to better manage and secure rapidly expanding data traffic and deployment at a large media and technology company to support high-volume traffic for internal applications.

Our advanced application security offerings are proving a key competitive advantage for on-prem deployments and as customers look to migrate applications to the cloud.

We believe application security is more essential in the cloud, and we are finding our security capabilities are leading the conversation with customers as they consider shifting workloads for the cloud.

This is evident in the strong attach rates we are seeing for our security solutions in public cloud transactions.

Growth in our virtual editions remained strong during Q4, with sales up over 35% year-over-year for the quarter and for the full year.

Revenue from our public cloud bring-your-own license and utility offerings more than doubled in the fourth quarter compared to the prior year.

This demand is being driven by a combination of existing customers lifting and shifting applications and customers new to F5.

Our advanced application delivery and security solutions are now available across all major public cloud providers.

We view these vendors as important partners as we look to help customers manage and protect their critical applications no matter where they reside.

Recently, we have enhanced our relationship with Amazon Web Services, earning certification for their security competency program and launching with the GovCloud Marketplace.

As part of our increased focus on cloud migration and enablement initiatives, we are excited to be involved in several AWS initiatives around the channel, including AWS' Marketplace Channel Incentive Program and its Channel Opportunity Registration Program.

We believe the scalability, feature set and reliability offered by TMOS, our iSeries platform and our application security solutions remain essential for customers as they look to support mission-critical applications and begin to explore multi-cloud environments.

We are committed to making these solutions available for a variety of purchasing models to meet our customers' needs, including subscription, enterprise license agreements and consumption-based pricing.

As we look to FY '18 and beyond, we are excited by the emerging opportunities across the application services market, and we are well positioned to grow our share in both hardware and virtual solutions.

In closing, I would like to thank the entire F5 team, our partners and customers for their support throughout our fiscal 2017 year.

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

The first question on the line is from Ittai Kidron from Oppenheimer.

I guess, François, maybe you can help me kind of figure out some of the mixed messages I'm kind of getting, or at least it's just my interpretation.

Like on one hand, the guidance, the third time in a row, I think, that you're taking down guidance relative to where The Street is, yet it sounds like you're very optimistic and you feel comfortable providing visibility into fiscal '18 that you'll be able to grow sequentially through every quarter.

Maybe, 2 questions here.

One, what gives you the confidence about your ability to grow starting with the first fiscal quarter of '18 through the rest of the year?

Number one.

And number two, can you help us better understand the realignment?

Clearly, you reduced headcount.

But at the same time, you talked about hiring.

Was it not a headcount that could be repurposed?

Or from what product areas you kind of pulled back resources?

Where are you putting them back in?

Help us understand where the dollars are going.

Thank you, Ittai, and good questions.

Both are actually related.

I'll start with the first one on the confidence we have going into 2018.

Look, what we're seeing is the -- there is potential great drivers of product revenue growth that are actually long-term drivers for the company where we are doing very, very well.

And that's the case for what we see in the virtual ADC market with our Virtual Edition.

We grew 35%, both quarter-over-quarter and year-over-year for the full year '16 versus '17.

And we think that's a long-term trend.

Our business in the public cloud more than doubled, both year-over-year and also in the quarter.

And we continue to see very strong growth in our security offerings.

So these drivers, we think, are emerging trends that are becoming meaningful and are longer term for the company.

So we're very excited about that.

That is actually linked to your second question around the realignment of resources that we made in the fourth quarter.

Essentially, we decided to raise the intensity and focus on these areas that are growth areas for the company.

And so we're doubling down on our investments in public cloud and in security.

We're also doubling down in our investments in the virtual ADC space.

And so these are realignments that we made both in our product groups, essentially in our R&D function, but we also made some adjustments at the front end of the business.

So in the global sales organization, we made some adjustments to focus more resources on our cloud enablement partners and also add security specialists.

We're doing similar things with our marketing organizations, focusing on these programs that target potential growth in the cloud.

So the timing of these adjustments is why you're seeing a sequential decline in headcount.

But we are going to be aggressive about hiring in these areas where we see potential growth.

As you look into your Virtual Edition and cloud business, is there any way for you to tell or track how much of this is just revenue that's moving from an on-premise deployment into just a different consumption model versus something that drives incremental consumption there, revenue upside somewhere, somehow down the road?

How do I think about -- because those numbers will grow quite some time as you move -- as your customers move from on-premise to cloud.

But how do I get a sense whether those are incremental and additive to the overall picture versus just a trade from one side to the other?

I think what we look at, Ittai, is when we look at our public cloud business, there are 2 components to that.

One component is essentially existing customers that are migrating workloads with us to the public cloud.

And generally, we have a very strong attach rate.

When our customers are migrating workloads where we have been supporting them, we have a very strong attach rate and win rate around migrating for the public cloud with them.

But we also see net new customers that go and start buying from F5 directly on our virtual edition in the public cloud.

And when I mentioned growth earlier in my comments, both areas of our public cloud business have been growing.

The other area that we'll look at is, as we make our virtual offerings more scalable, lighter-weight and we continue to enhance the management and orchestration story around these offerings, we think we're going to be able to address more applications within our own customer base that we're not supporting today.

And again, that's incremental -- an incremental business opportunity for F5.

Our next question on the line is from Jim Suva from Citi.

It's Jim Suva from Citi.

I believe last quarter, you saw a pause in, I think it was the EMEA region, with some delays due to road maps and pushouts and Brexit and such.

Can you let us know, has that continued to linger or have those come back?

Because it looks like it hasn't snapped back.

I mean, it was growth, but I'm just wondering if it's fully resolved or is still kind of lingering there.

And then I'll probably have a follow-up.

In -- generally, I would say there were 2 aspects of the situation in Europe that we mentioned last quarter.

One was more macro.

And I think we also said there were some elements that were linked to what we felt was our own execution in the region.

On the microenvironment, which included the Brexit situation and also some regulatory uncertainty, there hasn't been a fundamental change.

Some of these regulations we think get taken care of in the first half of next year.

But what -- we still think, at the micro level, there's quite a bit of uncertainty in Europe.

In terms of our own execution, as part of the realignment that we mentioned, we did indeed make substantial changes in the formation and shape of our resources in Europe.

And we have started to see some benefits from that.

We think we had good execution in Europe this quarter.

So we're cautiously optimistic about how we're executing in Europe, but we're still going through some changes.

So we want to be cautious about what we see in the next few quarters in the region.

Great.

And then my follow-up is on your guidance, both for the December quarter and then your longer-term guidance, can you help us understand kind of the difference between the product revenues and the service revenues?

You'd mentioned sequential growth every quarter.

Was that kind of for both of them?

Or is there some lumpiness or some transitions we should model for services versus product?

No, and we generally don't give guidance on product and services.

But I will say to the earlier question of our confidence, our services business, as we look out, we feel pretty good about.

And when we think that's going to be a key component of that sequential growth off of this Q1.

Beyond that, I wouldn't -- there's nothing I would give you to model, yes.

Our next question is from Alex Kurtz from KeyBanc Capital Markets.

Yes, just 2 questions.

Maybe you could talk about the importance you see in sort of the FPGA and hardware acceleration you guys have traditionally had in the technology and how that's evolving as you guys put more applications in the cloud with your virtual instance.

Do you see that as a point of increased R&D focus?

Or is that going to flatten out over time?

And just how that fits into the competitive landscape.

And then for Q1 in the guidance, just, Andy, if maybe you want to talk about how you see the different verticals growing year-over-year.

Maybe just a little bit of context of where you think the growth could be across the 3 main sectors.

All right.

This is Ryan.

So I'll take the first question regarding FPGAs.

FPGAs has definitely been a focus area for F5, and continues to be.

In fact, it's one of the major drivers of the iSeries platforms, actually, that we've launched over the last year.

And it's helping significantly in the [price of] performance generally on those platforms.

Everything we do is software-based, and then we look at accelerating different parts of the workload.

And so on our iSeries and our hardware, it's definitely been a significant benefit to the iSeries platforms.

Now as some workloads are moving into software and even more specifically to public cloud, at the moment we don't make use of FPGA and specific hardware technologies in those environments.

But we definitely can in the future, and it's definitely one of the things we are looking at to accelerate workloads in these software and virtual environments.

So...

And then on the verticals, generally, we don't guide on that.

But what I will say is if we look at government and in particular, fed, that was a little bit disappointing to us this quarter, given what we normally do in a Q4.

And I wouldn't expect that to repeat again as I look out to next year.

We have some good initiatives in service provider that, I think as we look out, could have very positive impact in that area, both on a road map side as well -- we'll talk about that probably more in March, both on that side as well as just go-to-market.

In the enterprise, we continue to feel good about as our lead story.

So...

Our next question comes from George Notter from Jefferies.

I guess I was just curious about -- François, you mentioned other consumption models for customers.

I think you referenced ELA's usage-based models.

Can you kind of talk about sort of the industrial, I guess, logic behind doing that?

And when might you implement that?

And how does that kind of wash out for F5 financially as you moved some of these models?

Is it a net positive, neutral, negative?

Just give us a sense there.

So just in terms of timing, to start with that.

We have made available our subscription offerings to our customers on a large scale in Q4, and we're doing the same with our enterprise license agreements now.

So we're pretty excited about offering this new type of consumption of our technology for our customers, because essentially it gives them more flexibility.

And what we're hearing from our customers is they want more flexibility in the way they deploy and scale our technologies and also the way they pay for it.

Because for some applications, there is uncertainty around how fast these applications are going to scale, how much throughput they're going to need, how long an application is going to be in production for.

And giving them more flexibility just allows them to put our technology in front of more applications.

So the real -- the industrial logic for us is twofold: it's -- one is serving the needs of our customers, and b is the opportunity potentially to serve more applications in more places.

That includes on-prem, on -- in private clouds and in public clouds.

We are seeing this issue of multi-cloud become a big issue for our customers.

And we're doing a number of things to enable them to consume security and ADC offerings across multiple environments, and we see that as a big driver of adopting F5 as a solution.

And then just to add on that, the impact of that.

So if we take subscription, if the volume of that takes up rather quickly, then yes, that could have an impact.

Generally, you'd see us start talking more about deferred revenue and total contract value, those types of things.

As we model out fiscal '18, we think we're going to see that taking up through the year.

But the incremental value that it's going to create, we think offsets.

But we're going to watch that very closely and we'll update you if we feel we think that's going to impact our longer-term model.

The end goal, of course, is that over the life cycle of a customer and looking at how long our customers utilize our technology, we believe it actually over time has significant increase to the overall dollars realized from each of those customers.

So hence, why deferred revenue and total contract value will come into play.

On the utility model, we see that as purely incremental, right?

It's -- our technology out in the public cloud, where people can pick it up and use it just using a credit card.

And that is something we've never offered before.

So small dollars still, but seeing that growth there, seeing it utilized in those environments, we just think adds incrementally to us.

The other thing there and, George, just for clarity, the subscription offerings and the utility offerings are available only for our software solutions.

So think of that available for virtual editions, either on-premise or in the public cloud, but it only applies to that portion of our business.

Our next question on the line comes from Michael Genovese from MKM Partners.

I just was wondering if you have a view, either from yourselves or from industry analysts, on what the TAM growth of your business is, specifically ADCs, how much should we think about them growing that market over the next year or 2?

And then secondly, in the past, we always heard you talk about credit revenue growth as a key kind of strategic priority for the company.

And just didn't hear as much conversation about that on this call, so is that still a key priority?

Do you have any kind of target for that?

And any additional words of strategy on how you plan to achieve it?

Mike, let me start with your second question.

Is product revenue growth a priority for the company?

Absolutely.

And some of the investments and realignment that we've made in the quarter are all about making sure that we maximize the resources that we're putting in front of the highest growth opportunities areas for the company.

And essentially, what we've done is we're not changing our operating model.

We have strong profitability and we continue to drive that.

But we are moving significant investments towards these high priority areas for product revenue growth.

So that absolutely continues to be a priority.

In terms of your first question around addressable market and growth in the market, there are -- depending on what sort of market numbers you look at, I think the general view of the market is that, over time, the hardware market is expected to decline slightly in sort of mid-single-digit growth and then the virtual ADC market is going to experience very strong growth, both for on-prem environment and in public cloud environment, and depending on how these segments are counted, et cetera, you end up with, in aggregate, sort of mid-single-digit growth.

I would say that, of course, our aim is, over time, to do better than the market in each of the segments in which we participate.

And then in security, there's a lot of security market segments over there.

We participated in a few key segments.

I mentioned the Web Applications Firewall in our prepared remarks.

That is absolutely a focus area for us and we are seeing very strong attach rates for our WAF offerings in -- especially in our cloud implementations.

And we're getting a number of customers that want to put WAF in front of more and more of their applications.

So that's a big driver, and I expect that market, the WAF market in particular, to grow at more than double digits over the next few years.

Our next question comes from the line of Vijay Bhagavath from Deutsche Bank.

My question is around the guidance and how to extrapolate it from a product refresh point of view.

And I think where I'm coming from is, given the guidance is weak versus expectations, I'd like to better understand which of the product portfolios in your view are performing or underperforming versus your own expectations?

And what's going on in the field, like what's the field asking for in terms of product refresh from F5?

So it helps us better understand the product cycle dynamics on a going forward basis, at least over the near term.

Vijay, I would say that first is -- the areas that are outperforming for us, I think we mentioned.

But in security, we have had a very strong year and a very strong quarter, both in enterprise and in service provider vertical.

We have very, very strong demand in there.

Our virtual editions, again, very strong demand.

You saw the growth number, 35% year-over-year.

And in the public cloud, we also are outperforming, more than doubling the business over the period.

And specifically I would say, in the public cloud, we have a very strong security attach rates because folks, not just these applications, the problem application security in cloud becomes a real issue.

The one area where I would say we didn't see the lift that we expected to see this quarter is on our iSeries in appliance.

Actually, in the total business for appliance.

ISeries in terms of the refresh, it continues to track with the refresh we had last cycle.

So the customer adoption is very strong.

What we're seeing from the field, to your question on the field, is actually interesting in that not only we're involved in a number of refresh and upgrades, but we're also seeing new applications for iSeries because iSeries has some capabilities specifically around encryption and SSL that are pretty unique.

And so we're seeing customers in the field want to deploy iSeries in front of new applications, even within an existing customer.

But the one area where we feel we have underperformed relative to our own expectation this quarter is the total amount of business we expected to see from appliances as part of the refresh.

We continue to think that the refresh is actually a driver of product revenue over the next 2 quarters, as we have more and more of our install base on the iSeries.

But for this order, we're a little cautious because we didn't see the lift we expected to see from appliances this quarter.

Certainly, François, very helpful.

Quickly, as a follow-up.

On the telco side, I'd like to get your views on how strategic is the telco piece of your business for you.

And the reason I ask is telco spending has been quite [weak in we saw during first guidance] yesterday.

So any thoughts on becoming more of an enterprise-focused company versus having both enterprise and service provider in the portfolio?

Vijay, there are dynamics in the service provider environment that are good catalysts for F5.

And we've seen that in 4G.

We think we're going to see a potential, even bigger effect in 5G.

A lot of these unlimited mobile data plans drive a lot of IP flows that need to be protected and need to be properly managed.

And the scale, this is an area where the scale, the acceleration of our hardware, the performance of our security solutions, our carrier-grade firewall is very unique.

And so no, we consider the service provider segment of F5's business to be strategic.

And in fact, in part of the realignment that we had in Q4, we enhanced the number of resources in that market because we feel that we are potentially underdistributed relative to the opportunity we have in the service provider space.

Our next question on the line comes from Jayson Noland from Baird.

Okay.

Great.

I wanted to come back to the WAF market.

The Gartner report you mentioned has F5 in the upper right, but also makes a point to say the market is moving away from stand-alone appliances to cloud-based WAF models, which makes sense for DDoS applications.

I guess, the question is, why are you a winner with a shift like that and competitors out there, like the CloudFlare or an Akamai or an AWS?

Well, so that's -- so on the WAF specifically, we do believe that it's moving to the cloud.

And I think, as I said, our attach rate as a data point for you, our attach rate with WAF solutions in the cloud is double the rate that we're seeing in on-premise applications.

And so that's why, for us, cloud and WAF is actually a very interesting driver of growth.

In on-premise, we are also seeing potential for growth, the growth in the WAF space.

One of the customers I mentioned in the prepared remarks, one of the large European banks essentially told us that they have tested a number of WAF solutions.

They've standardized on F5, largely because we have the best bot protection capabilities.

We have excellent performance on false positive, which is a key criteria for them.

We also have the ability to see a lot of the traffic, which allows us to implement a set of policy decisions for WAF that others cannot implement.

And today, they see roughly 10% to 15% of their applications having a WAF in front of them and they want to move to having 100% of their applications with a WAF, which is a great catalyst for us, both for the on-premise applications and some of them on the public cloud.

So we actually see the ability to have both presence as a key advantage relative to some of the players you have mentioned.

And on the last one, I'd mentioned on that is that we also have a hybrid offering with our -- we just launched the WAF Express on our Silverline capability.

We have WAF on-premise.

And the ability to offer both in a combination and to signal between the 2 is a very unique capability that F5 brings that we don't see any other pure cloud players offering.

And that makes a big difference.

Okay.

Thanks for the color and then a follow-up on U.S. fed that was down, by our math, over 25% year-on-year into the fiscal year end.

Did -- was that in line with expectations?

And any additional color you can provide there.

No, it wasn't.

In fact, as we dissected, we kind of see 2 dynamics in that area of our business, which we had a late approval of budget, which seemed to impact the extensive process of getting POs through.

And then, unique to the Fed space is, once the fiscal year ends, the process has to start all over again.

It's not like rolling into next quarter.

And then generally, just the buying environment seems -- there's enough uncertainty there that we were seeing that impact the business.

Hopefully, we'll see things firm up there, that we won't see a dynamic like that next year.

But you're right in your percentage down, and we were disappointed in that.

The next question on the line comes from Tal Liani from Bank of America.

I -- maybe part of my question was answered.

But I'm trying to understand -- your commentary is very positive, but at the end of the day, product revenues was down and you also have weak guidance.

So there is an issue.

And if you can elaborate on the weakness, where is it coming from?

And what are you specifically doing in order to address the weakness?

And a related question is whether virtual solutions are deflationary to the market.

If you are really strong, if you're setting, I think the first, first question, I'll ask it in a different way.

But if you're going to grow dramatically, let's say, in virtual solutions, does it mean it's going to be deflationary and the market might actually shrink for you or not?

I'm trying to understand the dynamics there, too.

Tal, let me start with the second part of your question on whether virtual editions are deflationary overall.

I would say that we believe, over a period of time, the software, the virtual ADC market opens up more applications and growth in the market in terms of dollars, both in terms of volumes and in terms of dollars in our market.

And that's essentially because it allows us to get in front of way more applications in way more places to consume not just our traffic management capabilities, but also our security capabilities, our analytics capabilities and a number of application services that we intend to bring to market.

So that's why, over a period of time, we think it creates growth in the market for us.

To your point on where there is a weakness, I think part of the reason you're hearing positive commentary from us is we had a record revenue quarter and full year in terms of revenues.

And we're excited about areas of the business that are very strong, that bode very well for the long term of the business.

In the quarter specifically, where we've seen some weakness and actually where we're being a bit prudent and cautious about Q1 is specifically in our appliance hardware business where we expected to see more of a lift in Q4 in our total appliance sales than we have seen as part of our refresh.

And that's the area of the business that is underperforming relative to our own expectations right now.

And one thing I would add, Tal, is to the discussion around this transition to software impact.

We grew 35% this year.

And interestingly enough, through the year, our average order size has stayed pretty consistent.

In fact, in Q4, we went up -- from last quarter, it was 115,000 up to 122,000.

So we still see this dynamic where if they go with software, though the price point for the software is lower than maybe the appliances they were looking at, they tend to buy more instances of the virtual edition and we see that offset.

So -- and that's coming through in the average order size.

So we'll see how this plays out as we go forward, but that's what we're seeing so far.

And maybe just one follow-up on the answer on the appliances.

So is that weakness going to stay?

Meaning, there's a signal from the market that there is less demand for hardware and the market migrates to software.

What drives the change?

It may take you a few years to migrate the portfolio.

At the end of the day, you're an appliance company.

Although you have virtual solutions, you're still an appliance company at the core.

Most of revenues are probably coming from appliance sales and most of the install base is appliance sales.

So does it mean these quarter trends, does it mean that the transition may take a long time?

Or what can you do in order to reverse the product trends?

Yes.

So Tal, I think, a couple of things.

In terms of the product trends, number one for us is, as we've said, doubling down in our investments, raising the intensity in these areas where we're seeing very strong growth, cloud, security, virtual editions.

In terms of our appliance, the portion of our business that's appliance-based, we've actually said we think we're going to perform.

I mentioned earlier that the market was -- overall, the market numbers were expected to decline over time at mid-single-digit rate.

We think we're going to perform better than market: a, because we're actually seeing great customer adoption of iSeries as part of the refresh; b, because we have very strong traction in the service provider space with our -- both our appliance and chassis-based solutions; and c, because we feel that a number of our customers are deploying our hardware solutions in front of new applications.

So count -- qualify that in terms of giving a specific guide on hardware for FY '18.

But we do think that we'll do better than market with our appliance solutions.

The question is coming from Simon Leopold from Raymond James.

I first just wanted to see if we could get a little bit of clarification in the segment trending.

Historically, we've never seen a sequential decline in the December quarter of services.

And I assume there are seasonal reasons in terms of your customer behavior why services would grow sequentially in December.

I'm just wondering whether or not that pattern is different this year and you would see services sequentially decline.

Yes, we don't generally break it out, but I wouldn't assume any different pattern than we've seen historically with services in December.

Great.

And then the bigger trending question I have is really the availability of 2 alternate options for enterprise customers.

One is just what do you see is the impact of hyper-converged infrastructure?

If enterprise is deploying that technology, how does that affect your market opportunities?

And then the other one is Microsoft Azure introduced load balancing functions in September.

So that's a new cloud option.

Wondering how you see that affecting your overall business.

Yes, Simon, I'll take the Microsoft question and then we'll -- Ryan will address your question on hyper-converged infrastructure.

Yes, so Microsoft's load balancing is no different, from our perspective, than other sort of load balancing solutions that are offered by native cloud providers like Amazon, also Google.

And our view on it is fairly simple.

We think there are some basic applications and requirements that will take advantage of these solutions.

But the market we go after for large enterprise customers, there are 2 things that we believe they'll continue to look for from F5.

Number one is for a number of application, there's a feature richness and depth, both in traffic management capabilities and in security capabilities, that are quite differentiated as an offering from F5, and that's not going to change.

And that's why we see such a strong win rate for us when our customers are migrating applications that we support to the cloud.

It's because of that feature depth that they want.

And then the second aspect is cloud portability or multi-cloud capabilities.

F5 offers -- in a number of ways, we allow customers to deploy their applications across not a single public cloud, but multiple public cloud and/or on-premise.

Things like being able to manage their applications from a single pane of glass across all these environments.

Things like the ability to manage licenses across multiple clouds.

Things like that.

Things like having the same security posture across multiple clouds.

All of those things are mission-critical for large enterprises.

And the this-or-that offering from a native cloud provider does not change that requirement.

So that's where we play and where we see a strong difference.

Ryan, on the hyper-converged infrastructure?

Sure, Simon.

Yes, regarding hyper-converged infrastructure, we actually partner with a variety of hyper-converged infrastructure vendors and we can actually run adjacent to the technologies, because hyper-converged infrastructure still need availability, still need security and still need services that we offer.

So whether we're running adjacent to the converged infrastructure or within the converged infrastructure, we actually partner with many of those infrastructures.

And it's basically a benefit to us and our technologies.

So...

I'd like to thank everyone for participating today, and we look forward to talking to you again at the end of next quarter.

Thank you.

Have a good afternoon.

Thank you, and that concludes today's conference call.

Thank you very much for your participation.

You may now disconnect at this time.

Have a great day.