F5 Inc (FFIV) 2019 Q1 法說會逐字稿

Good afternoon, and welcome to the F5 Networks First Quarter and Fiscal 2019 Financial Results Conference Call.

(Operator Instructions) Also, today's conference is being recorded.

If anyone has any objection, please disconnect at this time.

I'd now like to turn the call over to Ms. Suzanne DuLong.

Ma'am, you may begin.

Hello, and welcome.

I'm Suzanne DuLong, F5's Vice President of Investor Relations.

François Locoh-Donou, F5's President and CEO; and Frank Pelzer, F5's Executive Vice President and CFO, will be making prepared remarks on today's call.

Other members of the F5 executive team are also on hand to answer questions during the Q&A portion of the call.

A copy of today's press release is available on our website at f5.com, or an archived version of today's call also will be available through April 24, 2019.

The telephonic replay of today's discussion will be available for midnight Pacific Time tomorrow, January 24, and can be accessed by dialing 800-688-2171 or 402-998-0565.

For additional information or follow-up questions, please reach out to me directly at s.dulong@F5.com.

Our discussion today will contain forward-looking statements, which includes 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 the press release announcing our financial results and described in detail in our SEC filings.

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

With that, I'll turn the call over to François.

Thank you, Suzanne, and good afternoon, everyone.

Thank you for joining us today.

I'll talk briefly to our business drivers before handing over to Frank to review the quarter's results in detail.

We delivered a solid Q1, overachieving on earnings with revenue growth of 4%.

Year-on-year software growth of 21% drove our third sequential quarter of product revenue growth.

Focusing on software, public cloud continues to be our strongest software growth area.

In this quarter, we also saw increasing demand for our security solutions, particularly Advanced Web Application Firewalls.

Our new software consumption models, including Virtual Edition subscriptions and ELAs also contributed to software growth in the quarter.

Our ELA pipeline continues to grow, accelerating in Q1, and we expect ELA sales to continue to pick up as our customers continue to shift to multi-cloud deployments.

Overall, our software story is evolving to plan, putting us on pace to achieve our Horizon 1 target of 30% to 35% software growth in our fiscal year 2019 to fiscal year 2020 time frame.

Our Services business had another strong quarter, delivering 5% growth with robust gross margins, resulting from transformation initiatives we've been executing to improve an already effective and efficient business.

The scale, scope and expertise of our services team remains a differentiator for us, and with a customer satisfaction rating of 9.6 out of 10 for our technical support team, it is clear we are providing support at levels unmatched in the industry.

During the quarter, Systems also continues to perform as expected, with customers choosing our traditional appliances when they want to control and manage the end-to-end application delivery solution and in most high-performance use cases.

At this point, I will hand the call over to Frank, to review our Q1 fiscal year 2019 results and our outlook for the second quarter of fiscal 2019.

Frank?

Thank you, François, and good afternoon, everyone.

As François noted, we delivered solid revenue and strong EPS growth in the quarter.

First quarter revenue of $544 million was up approximately 4% year-over-year within our guided range of $542 million to $552 million.

GAAP EPS was $2.16 per share.

Non-GAAP EPS of $2.70 per share was well above our guidance of $2.51 to $2.54 per share.

The beats for GAAP and non-GAAP EPS were driven largely by strong gross margin, hiring, that was slightly behind plan and better-than-expected other income.

Q1 product revenue of $234 million was up 3% year-over-year and accounted for approximately 43% of total revenue.

Software was approximately 19% of product revenue and grew 21% year-over-year.

Systems revenue made up approximately 81% of product revenue and was down less than a 1% year-over-year.

Services revenue of $310 million grew 5% year-over-year and represented approximately 57% of total revenue.

On a regional basis, in Q1, America's revenue was flat year-over-year and represented 54% of total revenue.

EMEA revenue grew 7% year-over-year and accounted for 27% of overall revenue.

This quarter we've combined our APAC and Japan segments for external reporting to reflect the way we now view the business internally.

Revenue for this combined region grew 11% year-over-year and accounted for 19% of total revenue.

Sales to enterprise customers represented 65% of total sales for the quarter.

Service providers accounted for 14%, and government sales were 21% including 10% from U.S. Federal.

In Q1, we had 3 greater-than-10% distributors.

Ingram Micro, which accounted for 17% of total revenue, and Westcon and Arrow, each of which accounted for 11% of total revenue.

Turning to our operating results.

GAAP gross margin in Q1 was 84.1%.

Non-GAAP gross margin was 85.2%, slightly better than our expectations, driven by improving product margins, which were benefiting from an increasing mix of software sales, as well as continuing strength in our services margins.

GAAP operating expenses were $299 million.

Non-GAAP operating expenses were $262 million.

Our GAAP operating margin in Q1 was 29.1%, and our non-GAAP operating margin was 37%, above our guidance of in the mid-30% range, driven largely by gross margin strength in operating expense efficiency.

Our GAAP effective tax rate for the quarter was 20.8%.

Our non-GAAP effective tax rate was 21.5%, in line with our 21% to 22% guidance range.

Turning to the balance sheet.

In Q1, we generated $198 million in cash flow from operations, which contributed to cash and investments totaling $1.55 billion at quarter-end.

DSO at the end of the quarter was 54 days, driven by service maintenance renewals at the end of FY '18.

Capital expenditures for the quarter were $21 million.

Inventory at the end of the quarter was $31.6 million.

While our adoption of ASC 606 had a de minimis impact on our income statement, we did experience a few changes on our balance sheet items.

Deferred revenue increased 16% year-over-year to $1.15 billion.

Approximately, half of the $134.2 million increase over the previous quarter was due to the adoption of 606.

Other current and long-term assets increased by $135.5 million from the previous quarter, of which approximately 80% was due to the adoption of 606, as we are now capitalizing on those receivables and commission paid per sales of service contracts.

Finally, retained earnings increased by $130.7 million in the quarter, approximately $36 million of which was driven by the adoption of 606.

We ended the quarter with approximately 4,580 employees, up 170 people from Q4, as we executed on our plan to aggressively hire in our growth areas.

In Q1, we repurchased approximately 569,000 shares of our common stock at an average price of $177.64 per share for a total of $101 million.

Now let me share our guidance for Q2 of '19.

Unless otherwise stated, please note that all of my comments reference non-GAAP operating metrics.

Overall, we remain confident in our position in the market and in the growth opportunities for the business with solid software momentum.

We believe the long-term trend towards multi-cloud environments is strong and will be a fundamental growth driver for the solutions we offer today and those we will launch in the first half of calendar 2019.

While sales to enterprise customers continues to remain strong, we have seen some softness within our service providers' vertical, and some of our larger customers are planning their next-generation application architectures.

F5 is positioned very well to capitalize on the massive increase in application traffic anticipated with 5G architectures, but we believe it is prudent to factor in a measure of near-term softness with our service provider customers in our outlook.

Our guidance does not include the impact of a U.S. Federal government shutdown, should it extend into February.

With this in mind, we are targeting revenue in the range of $543 million to $553 million.

We expect gross margins in the 85% to 85.5% range.

We're estimating operating expenses of $270 million to $282 million.

You recall that last quarter we mentioned that we expected operating margin to move down slightly in Q2 and Q3, before moving into the upper 30% range in Q4.

We anticipate our effective tax rate for the year will remain in the 21% to 22% range, we previously provided for the full fiscal year, with some fluctuations quarter-to-quarter.

Our Q2 earnings target is $2.53 to $2.56 per share.

In the quarter, we expect share-based compensation expense of approximately $40 million, and $1.8 million in amortization of purchase and tangible assets.

As reminders, we anticipate stock-based compensation to be in the range of $155 million to $165 million for the year.

Capital expenditures are expected to be in the range of $110 million to $130 million for the year.

This range includes approximately $70 million of cost related to our previously announced move of our corporate headquarters to F5 Tower in Downtown Seattle, as we ready the space for occupancy this year.

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

François?

Thank you, Frank.

Before we move to Q&A, I'll spend just a few minutes on the trends we are seeing in the business, highlighting some customer wins from the quarter and talking to innovation at F5.

On January 15, we released our fifth Annual State of Applications Services report.

With input from nearly 2,000 respondents across a range of industries, company sizes and roles, the report provides a view into application trends impacting our customers globally.

One of the key takeaways from this year's survey is that, as organizations progress on their digital transformation journeys, they see application services as vital for cloud adoption.

The report also shows that multi-cloud has evolved from an experiment to a key strategy, with nearly 90% of respondents reporting they are implementing multi-cloud architectures.

Enforcing consistent security and ensuring reliable performance in these multi-cloud environments remains challenging.

These and other trends highlighted in the report aligned with our vision of expanding F5's reach and role and with our efforts in the last year to repurpose investment and focus on growth areas for our business.

These trends are also playing out in real time with our customers, and you can see them in some of our customer wins from Q1.

These include a win with a global software and service provider customer who is already leveraging F5 solutions across their multi-cloud environments, including a bring-your-own license in AWS Marketplace and Virtual Editions in Equinix and Azure.

This quarter, they purchased licenses for their procurement and supply-chain software-as-a-service offering on Google's Cloud Platform.

Customers increasingly are making decisions on a per-app basis and during Q1, we had a per-app public cloud deployment with a U.S.-based crypto currency exchange.

This customer wanted to differentiate its services to the financial industry through best-in-class security solutions for block chain transactions.

They chose F5's Cloud Edition Virtual Web Application Firewall for its more robust performance over native public cloud tools and BIG-IQ for the ability to manage and scale their per-app infrastructure.

We also provided a software subscription consumption model to match their end-user billing cycles.

There are 2 BIG-IP Cloud Edition wins and highlights from the quarter, one with an international stock exchange and the other with a large energy supplier in Europe.

In both cases, customers are using Cloud Edition for application service isolation, enabling agile application development.

This includes simplifying the move from a development environment into production across multiple clouds and ensuring policy compliance through self-service templates.

We continue to see security use cases driving a significant portion of our customer conversations and net new customer wins.

That's not surprising when you consider data from our application services report shows that customers are increasingly deploying a combination of security services to protect their applications and data.

Our Advanced Web Application Firewall solution plays right into that trend, and our bot detection and mitigation capabilities are a significant differentiator.

During the quarter, we had a number of customers select our advanced WAF solution for its anti-bot and machine-generated traffic monitoring and blocking capabilities.

This includes a major U.S. city's Police Department that needed enhanced features and functionality beyond the native cloud tool sets that they have been using.

Turning to service providers.

We are driving continued adoption of our NFB solutions in new areas of business with our service provider customers.

In Q1, we closed the deals for our DNS offerings with multiple Tier 1s globally.

These customers are leveraging the combination of our extreme-scaled DNS infrastructure, along with the ability to protect that infrastructure with our integrated security capabilities.

In addition, we also continued to win 4G and now 5G-related deals with our mobile customers, and we see continued strength in firewall use cases including GPRS tunneling protocol.

We see 2019 as a significant pivot point for our business, a point where our customers will begin to experience a different F5.

What do I mean by that?

I mean, they will be able to migrate or upgrade their F5 instances in minutes and will be able to consume F5 technology as a native cloud service without owning F5 hardware or software.

They will be able to try and buy F5 technology in new ways.

Over the last 18 months, we significantly shifted our investments and resources towards innovation in automation and orchestration, cloud native software and software-as-a-service, and we are excited, our customers will experience the new capabilities firsthand in 2019.

BIG-IP Cloud Edition was introduced in May and continues to gain traction with customers wanting to consume ADC on a per-app basis or wanting to offer better SLAs to their DevOps users.

The majority of use cases for BIG-IP Cloud Edition continue to be net new applications we were not addressing before.

As we continue to bring new solutions and new innovations to our customers, F5's reach and role will continue to evolve.

Our development teams continue to drive our cloud native software and F5-as-a-service platforms forward.

These are 2 disruptive platforms that we are convinced will change the paradigm of application delivery.

Both are well on track for first commercial availability in the first half of calendar 2019.

And I have to tell you, I am so proud of these teams.

They have moved forward relentlessly and have taken these solutions from paper to reality in an incredibly short period of time.

Both of these offerings are now at beta stage and in the hands of early customers, providing feedback on initial features.

At the same time, we are moving full speed ahead with internal digital transformation required to support our digital touch motions and ensure frictionless procurement and service renewals for our new offerings.

It's a different kind of innovation, but innovation nonetheless.

We believe that robust and constant innovation is a necessity for F5, so we are also innovating in new ways.

For more than a year now, we had teams dedicated to focusing on testing new disruptive innovations in technology, business models or customer segments.

Operating under the supervision of Tom Fountain, our Chief Strategy Officer, each team is led by a General Manager and staffed with dedicated employees.

We expect innovations will be complementary to our goal of delivering the broadest and most consistent portfolio of app services across cloud and on-premises environments.

During Q1, we announced one of the first innovations to come from this program and the open beta of our Aspen Mesh solution.

With the shift from monolithic to microservice architectures, a rapidly increasing number of applications are being deployed in container environments.

Yet there is still a need for services that help enterprises monitor, manage and control microservice-based applications at one time.

Aspen Mesh provides critical enterprise features in a platform built on top of this field, so organizations enjoy the benefits of an open-source approach without forgoing the features, support and guarantee needed to power enterprise applications.

It's very early days for the solution, but we've already got customers who are very interested in exploring it.

These innovations represent incredible forward movement and speak to the drive and dedication of our global team.

In closing, my thanks to the entire F5 team, our partners and our customers.

We are excited about the progress we are making toward our long-term vision for F5.

We are expanding our reach and our role, expanding our reach by taking our industry-leading solutions beyond traditional data centers and into private and public clouds and expanding the role we play for applications by providing additional high-value services.

With that, we will now open the call to Q&A.

(Operator Instructions) And our first question is from Sami Badri of Crédit Suisse.

First wanted to kick it off with just talking about your guidance for 1Q, or calendar 1Q coming up, and it does not include any partial government shutdown impacts, just as a clarification, as I heard that earlier.

And then the second piece of that is, if there is any customer impact so far from the U.S. partial government shutdown, that would be great color.

Sure Sami.

So it's Frank.

I'll take that one first.

So to answer the second part of the question first, we have seen an impact, but it's not in probably the way that you might expect.

We've actually won business, but there is no one in the central procurement agency to actually process the paperwork.

And so our guidance anticipates that this does not go on through the remainder of the quarter, but somebody's actually going to be there to process or we will find another route in which to process those orders.

It -- if we find that this continues to go throughout the quarter, we probably would expect some impact that is not anticipated in our guidance.

And just to complete that on the question, and no, we have not seen an impact outside of the federal government in our broader enterprise business to date.

Got it.

And then my second question has to do with the GAAP services gross margin that continues to expand, and it continues to hit a record high as of this quarter.

Can you walk us through what are the dynamics that are driving this expansion?

And could you potentially attribute the EPS beat in the quarter to post-services margin expanding?

And on top of that, the ELA that was reported in the quarter?

Yes.

So the dynamics on the Services business, there are essentially 2 initiatives we've put in place last year that are bearing fruits.

Generally, there is a set of transformation initiatives we have in services.

But specifically, we are leveraging more tools and more AI tools and automation to deflect as many cases as possible where we can, and it's allowing us to have better efficiencies, better utilization of our resources.

We've also embarked on having a better distribution of our resources globally to support different geographies, and both of these efforts are benefiting in our gross margins.

The next question is from Samik Chatterjee of JP Morgan.

François, I just -- wanted to start out with the Horizon 1 targets that you have, which kind of you alluded to in terms of software growth of 30% to 35% this year.

So clearly, you're expecting a acceleration in the coming quarters.

Just want to understand if you expect that to be more driven by the Cloud Edition product that you're ramping up on?

Or is there also contribution kind of that you're thinking of from the products that are coming up in terms of cloud native apps as well as F5-as-a-Service coming through data this year?

How you're thinking about kind of the driver of this acceleration in software this year?

Hi, Samik.

Yes, we are expecting an acceleration.

Generally, we feel we are on track with this Horizon 1 target.

But for everybody's benefit, we said in Horizon 1, which is 2019 and 2020, we expected software growth to be in the 30% to 35% range.

And we still feel that when you look at these 2 years in aggregate, that's where we're going to be.

So there is going to be an acceleration.

The contributors, Samik, in 2019, I do expect Cloud Edition to be a meaningful contributor to that growth.

We have seen continued traction with Cloud Edition.

We did actually more deals on Cloud Edition just in this past Q1 than we did for all of 2018, so we are seeing a pickup there.

And I also expect that in 2019, we will see meaningful contributions from our new modes of consumption, specifically this ELA, these enterprise license agreements and the subscription models, which are also gaining traction with our customers.

The newer products that will be released in the first half of calendar '19, specifically, the cloud native app services platform and our F5-as-a-Service, our SaaS offerings, they will start contributing in 2019.

But I would expect that the more meaningful contribution comes in 2020 for these newer propositions.

Got it.

And I just had a quick follow-up for Frank.

The frantic pace of repurchases moderate over the last -- over what we have seen as a pace for you over the last year.

Is that something procedural in terms of like blackout periods, et cetera?

Or is this more of a reflection of how you're thinking about capital allocation this year?

I think I would just say, capital allocation not just this year, but just broadly, how we think about our capital location strategy.

We think cash is very strategic asset, and for the first time in a long time, we're actually getting some decent interest rate return on it that we saw a beat on our other income.

It's clearly not necessarily where we want to beat.

We want to beat on the top line, but we'll take it on the operating -- on the other income line as well.

I think share repurchase is one of several alternatives for our cash.

Dividends are also a possibility, M&A is also a possibility and several other things.

And so we view this as strategic to the business, and we also believe we are likely going to be in the $100 million to $150 million range for the quarters to come.

And so I think that should be the expectation that you set.

It's what we baked into the guidance that we've given you.

The next question is from Paul Silverstein of Cowen.

If we could just focus on the telecom segment, François, if I'm looking at the numbers correctly, we'd have to go back over 5 years the last time telecom was this low.

It looks like you did around $76 million down from the $100-plus million level that prevailed throughout fiscal '18.

That's a $30-plus million drop.

I know you made some comments during the call, but I'm hoping you can give us more insight in terms of what is going on in that segment and your expectations going forward.

Yes.

Hi, Paul.

So generally, we had a soft quarter on service providers in Q1, and we actually expect the softness to prolong for a couple of quarters.

The softness was particularly marked in -- more in North America than globally.

And I would say that generally, what we're seeing is we are in a bit of a transition between 4G and 5G where we had a number of projects, 4G-related projects that are kind of tailing off, and 5G-related projects that haven't yet picked up.

We feel pretty good about our position for 5G because as 5G radios get deployed, we're going to be in line of that traffic.

So we expect to see potentially significant capacity upgrades down the road as that 5G traffic starts hitting the GI core.

But that's not in place yet, and we think we are seeing a bit of a transition from one to the other, and we are in between.

François, also -- I'm sorry, go ahead.

No, as you say, we also saw a couple of projects that we won in quarter that were pushed out that we think will pick up in the next quarter.

But if you look at the broader trend, which we also saw last quarter by the way, we're soft in service providers in Q1 -- sorry, now at Q4, that is kind of a similar trend we're seeing.

This transition between 4G and 5G.

François, just to be clear, I understand it's hard -- in situations like this it's hard to project or forecast, but given the magnitude of the softness where, again, from the $100 million, $110 million quarterly run rate that have prevailed for the past 3 years, this dramatic fall-off -- if this -- do you have visibility that this is primarily or just a function of the 4G to 5G transition.

How much of this is true insight?

How much of this is speculation?

I would hope more of it is insight.

I generally think we are experiencing, we are in the middle of this transition, Paul.

There -- of course, there's always areas that you can look at and say, look, there are areas where in terms of go-to-market, we could execute better.

In fact, we are in the process of hiring at the front-end of our business, and one area where we are actually doing significant hiring is in the service provider space, both in North America and internationally because we see strong opportunity.

We think that architecturally, we're well positioned.

We brought in a new GM as you know, James Feger, a few months back, and we are gaining a lot of clarity around some of the future developments we are going to make.

So generally, I feel good about where our service provider business is going to go, but I do think the softness we are seeing is not going to go away in just a quarter or 2. I think we're going to see that for a few quarters.

The next question is from Alex Kurtz of Key Capital Markets.

Just on the ELA outlook, can you just kind of reset for us how long the enterprise sales organization has been talking to your top enterprise accounts about ELAs?

And what's your multiyear outlook for ELAs as far as adoption within your enterprise accounts or service provider accounts?

And kind of what it's done maybe to deal size, share wins, any kind of qualitative, quantitative feedback on kind of, how long it's been in the system for the sales organization and kind of what outcomes you're seeing from it?

All right.

Thanks, Alex, I'll start and then I'll ask Chad Whalen to add in terms of the pickup with the sales team.

Last year, we introduced the ELAs just last year and really in 2018, we're essentially, experimenting with the sales motion.

We now launched it as of November to our sales team, and we are seeing significant excitement and traction with it.

In terms of your question around the multiyear outlook for ELAs, I would say, we expect over time, in our Horizon 2 for a meaningful portion of our software business.

If not the majority of the time to be ELA or subscription-based.

And we'll see that, we believe, both in the enterprise space and to some extent, in the service provider space.

So it is a meaningful and important development for us.

It gives our customers a lot more flexibility around where they deploy their licenses and when they have uncertainty around life cycle of an application or the amount of capacity they'll need for certain applications.

It's a great vehicle for them to deal with that uncertainty, and it also allows them to consume much faster because they don't have to deal with multiple procurement cycles.

So for the first ELAs that we've signed, we're actually seeing a good opportunity to expand or move ELAs when we renew them sometime in 2019.

And just to clarify, every sales -- every account exec can quote out an ELA?

Or is it just in certain pods and certain verticals?

Yes.

Hi, Alex.

This is Chad Whalen.

Yes, every account exec can and does quote out ELA.

And in fact, we just launched an aggressive incentive campaign for all of them.

And that's really driven appreciable increase of the pipeline of opportunities.

At the end of the day, our customers are really embracing this vehicle because it's an easy commercial construct to consume our services in any kind of mode that they want across the different application suites.

Whether it's on-prem or in the cloud, it's a great vehicle that can take away some of the complexity as we are going through these digital transformations.

In terms of the adoption from our sales team, it takes time to get the motion right in the market, understanding how to size it from a customer perspective and take friction out of that process.

What we're seeing now after we've spent some of the time that François talked about, in terms of pressure testing and learning last year, we're getting a lot more velocity in the motion, and we are seeing that translate into the pipeline of opportunities now and in the future quarters.

The next question is from Jim Suva of Citi.

When you mentioned about your cloud native solutions without having to buy F5 hardware, can you walk us through such transactions?

And specifically, some economics of it, dollar amount, gross margins or just generally, how we should think about that on the premise that this continues to increase?

Is it -- is there any way for us to frame about the detriment to the hardware and the uptick on the software and the impact of margins in dollars?

Yes.

Hey, Jim, let's start with margins.

As you know, our gross margins in hardware are in the early 80s, and our gross margins on cloud native software by bought as a package software are going to be in the early 90s.

So there is not a huge difference.

We said in our guidance that in our Horizon 2, which was 2021, 2022, we potentially would see a bit of an uptick in gross margins, we're in the 85% range now, and we would be in the 85% to 87% range in that Horizon.

As it relates to the price or the top line impact of this, the equation is actually fairly simple for us.

The hardware today, we -- primarily, what our customers consume today, before introduction of our Cloud Edition was hardware and Virtual Editions.

These have been largely consumed on-prem, but we have a very rapid growth now happening in the cloud.

The new package to offer products that we're releasing, the Cloud Edition that came out last year and this cloud native application services platform that's coming out in the first half of '19, those are opening up new use cases and allowing us to address applications that we have not addressed in the past but we've characterized as the longest tail of applications.

The price per unit for each of those applications is going to be less than when you're buying a big unit of hardware, of course, but the volume of applications we can address is much greater.

And so we look at it as an expansion of our addressable market, and we think that largely these new platforms address an incremental market and an incremental opportunity for us.

The next question is from Simon Leopold of Raymond James.

I wanted to come back to the topic of capital allocations.

The company, up until this most recent quarter, has been pretty steadily buying back at least $150 million.

And then with the renewal, you updated

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with an additional $1 billion.

I want to see if we can get a better understanding of the board's logic and your logic for why wouldn't you institute a dividend of perhaps, 3% or 4% yield?

That should give you some wiggle room for maybe $75 million to $100 million per quarter if you go to a dividend and be attractive to a larger set of shareholders.

Could you help us understand that?

Yes, Simon.

Look, I will bring you back Simon to what we said at our Analyst and Investor Meeting in March.

We are pursuing a growth strategy, and we laid out what we think the financials are of that growth strategy and part of that, we said, is we want to use our cash as a strategic asset to pursue that growth, some of which could be used potentially for acquisitions.

And so we want to have that flexibility.

If we see opportunities in the market to accelerate our growth or derisk part of our plan to take the opportunity and use our cash to the strategic asset to do that, and we don't want to lose that flexibility because that's the strategy we are pursuing.

And could you just outline your acquisitions philosophy in terms of what type or size of deals would you be biased towards technology tuck-ins?

Or larger deals that might require the company to actually take on debt?

Simon, here's what I would share with you about our philosophy as it relates to acquisitions.

We feel that we have a significant opportunity to extend our reach in terms of being able to reach every application anywhere.

We think the world is becoming more application-centric, we believe our growth is going to be linked to applications, and we want to reach every application anywhere.

In addition to that, we offer a number of app services today, and we believe we have an opportunity because of our position to offer more application services and expand our role.

We will look at acquisitions that allow us to accelerate the expansion of our reach or the expansion of our role.

And when you look at it within this context, we may look at things that are what you would call tuck-ins or even acqui-hires or small acquisitions, and/or there may be opportunities for things that are bigger.

We are not constrained, and we're not looking at it just in terms of is it smaller-based, we are really looking at it in terms of, is there a strategic fit?

But the most important thing for me, as we go through and potentially explore these opportunities is to make sure that we remain disciplined about it, disciplined in terms of, of course, being continuing to focus on organization -- on organic innovation as our first priority and disciplined in making sure that if and when we make an acquisition, that we have truly thought through how we create value from having the asset inside of F5 as opposed to outside.

And that -- as a result of that, we have very strong value-creation plan through a transaction.

The next question is from Jason Ader of William Blair.

I have 2 questions.

First, can you comment on the federal strengths?

It looks like that grew about 30% year-over-year, and love to get any comments on what's happening there?

And then secondly, François, could you remind us the difference between the Cloud Edition and the upcoming cloud native app services platform?

So we can kind of level set the differentiation there?

Sure.

I'll take your first question.

And Kara, you will take your second one.

We generally have a strong fourth quarter on federal.

So we have a good quarter there, what we saw specific traction in securities in that space.

And specifically, with our SSL orchestration solution.

So we announced in 2018 that we were coming to market with new solutions to provide encryption, decryption of SSL traffic and build a chain services for security stack inside of large enterprise customers.

We're seeing traction actually across the enterprise base with us, we are very excited about the pipeline we have for the solutions, and our federal team was early off the blocks with the solution.

And as a result, we had a pretty strong quarter there.

And with respect to your question about the difference between Cloud Edition and our cloud native applications services, I'll call out a few of the distinctions.

Our Cloud Edition is based on our industry-leading BIG-IP application delivery controller platform and so what that is, is effectively a -- our Virtual Edition, which is license and a per-app model to allow for isolation of services for those application services.

With our BIG-IQ Centralized Manager Solution and that enables a whole bunch of new use cases for our customers, including things like operating-dedicated instances for each of their applications so it's a per-app model, as well as application troubleshooting, such that application developers no longer have to go through tedious ticketing processes to get things examined in terms of if applications go down.

Another component of the Cloud Edition is something that is really targeted for our customers that have already invested heavily in our BIG-IP platform and want to extend the reach of that platform to more applications in their environment.

Now in contrast, the cloud native application services is -- will be a pure software-based solution.

It will be only available as a software subscription and that will be targeted to more of a developer and a DevOps audience.

And is intended to provide very easy-to-use, very intuitive insertion of application services into applications at the time of the application inceptions, which means that it will come out with very strong integration in the CI and CD pipelines.

The next question is from Tal Liani of Bank of America Merrill Lynch.

Hope that you can hear me okay.

I wanted to discuss the slowdown you discussed in the prepared remarks.

I still don't understand if the slowdown is, it's more limited to just service providers, telecom service providers kind of slowing down purchases?

And then, why is it just there or -- and/or the government and what about the general enterprise?

What do you see in the general enterprise?

I am trying to understand, if also during the quarter, if you noticed the slowdown kind of throughout the quarter or it deteriorated, kind of what was the seasonality within the quarter?

Hi, Tal.

So let's take the 3 segments that you brought up.

So no, in the federal space, we did not see a slowdown.

Frank mentioned to you the situation we have right now, where we won business that cannot be processed but we hope this resolves itself over the next few weeks.

So no change in the federal government space.

Largely in the enterprise space, if I look at it globally, I would also say that generally, there's been no change in buying behavior.

We do hear from our customers that they are watching the micro environment and being a bit cautious about their future plans.

But that potential consciousness hasn't translated yet into any change in buying behaviors in the general enterprise space across the globe.

In the service provider space, as I said, it was a -- I believe it's a transition we are seeing a bit between 4G and 5G.

And specific to what we've seen in terms of projects tailing off and net new projects haven't really pick up yet.

There wasn't a particularly linearity, as you know service provider business can be quite lumpy, so there wasn't a particular linearity in the quarter associated with that.

Now 5G has a lot of Edge data centers.

How do you participate in Edge data centers?

Is it playing to your strengths, or is it going to be more generic solutions from other vendors?

No.

So we participate potentially in several ways in 5G.

But the first way is we are in line of a lot of the core traffic from mobile service providers, and 5G radios are going to bring more traffic onto these core.

And so we expect to see capacity upgrades as a result of these deployments.

When the architectures evolve to a different 5G core, and not every service provider will go through a 5G core.

But when the architectures evolve to that, I think we will have an opportunity to expand our role, and we will get into that in future calls.

But generally, we see ourselves having probably an expanded role in 5G from what we have to date.

So far we discussed just the demand side, not the supply side.

Just the customers and verticals.

What about the supply side?

What about your portfolio, what are the plans for 2019 in terms of product launches and things that are coming out to the market?

And what do you think is going to -- could have or the potential of changing growth trajectory more materially than other things?

Your question, Tal, is specific to service providers.

No, no, no.

My question is more general.

We spoke about the demand based on verticals but now my question is about the supply.

Meaning, your product portfolio changes your planning for 2019.

Could you just give us a kind of the outlook, given that we are at the beginning of the year, changes you're planning for 2019?

Things that you think could be material, more material than other things you're offering, et cetera.

Yes.

So a couple of things, Tal, the first thing, if we're looking at it in the context of 2019, or actually, products and solutions that we've brought to market in the last 6 months that are going to ramp up through the year.

And I would point to 3: one is our Advanced Web Application Firewall is gaining a lot of traction.

We have actually a very strong security quarter.

We are specifically, as you know, bot defense has become a very important piece of both service providers and enterprises, and our performance and differentiation on bot is unique and we believe, unmatched in the industry.

So that's one and that's -- we offered that on our event yesterday and we'll bring more features and products around bot defense throughout the year.

Second is Cloud Edition, I've talked about that, that will also continue to ramp throughout the year, and third is the new security offering around SSL orchestration.

We have that offering in the past, but it was an offering that required significant involvement of professional services.

We've just released the solution that can be deployed much faster and much easier by our customers and we're seeing enormous traction with our solution.

So I expect all of these things to contribute to 2019.

I expect our NFB offering that we also released in fourth quarter of 2018 to contribute to our numbers in the service provider space in 2019.

And then, we are going to release new products that I talked about in the first half of '19, which will start to contribute, but again, will have a bigger impact in 2020.

So when you look at it and aggregate to use your term, Tal, on the supply side, I think we have an exciting pipeline of products and offerings that are going to continue to the top line going forward.

The next question is from Catharine Trebnick of Dougherty.

Can you talk a little bit about AVI Networks.

4 or 5 -- 5 years ago, we always heard A10 nipping at your heels.

In the last 6 months, the buzz on AVI has picked up.

And can you tell us maybe or quantify the number -- types of use cases that you run up against them?

And then, what's your strategy to outflank them?

Thank you, Catharine.

So specifically, so we're not dismissive of any of our competitors, however small they may be.

And so in the case of AVI, we don't see them that often, when we do see them, we actually like our win rate.

And that's we probably haven't seen them as much because we haven't played in the long tail of applications as much as we're going to be playing in the long tail of applications in 2019.

And as I mentioned, earlier, both on our Cloud Edition and the cloud native app services platform that Kara described, we are bringing to the market a per-app consumption model, as well as really lightweight nimble cloud native capabilities, combined with our overall capabilities in service and support and scale and a heritage of 2 decades of supporting mission-critical applications for our customers, and we don't think anybody is going to match that anytime soon.

And so we actually feel very confident about competing with them when we see them because again, that's frankly not a very frequent occurrence.

Our next question is from Rod Hall of Goldman Sachs.

You mentioned earlier, I think, François, that you guys are at least want to preserve some capital for acquisitions?

Or maybe that's part of the capital plan.

I just wondered -- could you talk a little bit about technology areas where you would like to expand the business in places where you think you may have deficiencies?

Or are you thinking more of something aimed at the core of the business?

I mean, just kind of help us understand without giving us I guess too much what sorts of areas you might be interested in?

Then I have a follow-up.

Yes, Rod.

So this one is a difficult one as you can imagine.

I would tell you if you look at our expansion of reach and role, you will see that expanding our reach revolves more around software and cloud, and expanding our role revolves more around other application services that we might want to offer.

And so those would be, if you think about the Horizon and the way we look at the world and the filters we use, those are the filters that I would give you today for what we might do if, in fact, we find something that is of interest to us.

Can you say which of those 2 reach or role is more strategically important?

Both are.

Okay.

And then, just as a housekeeping question, do you have a minimum cash balance that you guys feel like you need to run the business?

Rod, I think, we generally think of probably in the $400 million to $500 million range.

Okay.

So you're kind of there, Frank, is that right?

I'm sorry, what do you mean there?

We certainly have got more than our minimum.

Yes, we've got $1.55 billion.

I just...

Okay.

One of your total cash and investments, so you can run that down to $400 million, $500 million comfortably.

Below that you wouldn't be comfortable?

That's right.

So with that, was the last question for today's conference.

And that concludes today's conference.

Thank you for your participation.

You may disconnect at this time.