F5 Inc (FFIV) 2019 Q4 法說會逐字稿

Good afternoon, and welcome to the F5 Networks' Fourth Quarter 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 will now turn the call over to Ms. Suzanne DuLong.

Suzanne, you may begin.

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 today's call.

A copy of today's press release is available on our website at f5.com, where an archived version of the call also will be available through January 27, 2020.

The replay of today's discussion will be available through midnight Pacific Time tomorrow, October 24, by dialing (800) 585-8367 or (416) 621-4642.

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 (inaudible) 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 will talk briefly to our business drivers before handing over to Frank to review the quarter's results in detail.

Customer demand for consistent application security and reliable application performance across multicloud environment show a 5% total revenue growth in our fourth quarter.

Strong customer demand for security use cases, including Web Application Firewall and identity or proxy as well as continued ELA traction fueled our second consecutive quarter of 91% software growth and drove overall product revenue growth of 3%.

F5's application services are making it possible for enterprises and service providers across the globe to deliver digital experiences with the reliability and speed their customers expect.

Our software growth was partially offset by our systems business, which was down 15% as customers increasingly looked to consume F5 services as software.

Our Services business delivered a strong 6% revenue growth and continues to produce robust gross margin with consistently strong attach rates.

I will speak more to our business dynamics later in my remarks.

Overall, we are pleased by the acceleration in our transition to more of a software-driven business, and the team is executing very well against our long-term strategy.

Frank?

Thank you, François, and good afternoon, everyone.

As François noted, we delivered another quarter of strong revenue growth.

I'll speak first to our fourth quarter and then to our fiscal year results.

Q4 was our first full quarter with NGINX, and NGINX' contribution is fully integrated into our results.

Fourth quarter revenue of $590.4 million was up approximately 5% year-over-year and above the top end of our guided range of $577 million to $587 million.

GAAP net income for the quarter was $94.8 million or $1.57 per share.

Non-GAAP net income was $156.7 million or $2.59 per share, also above the top end of our guidance range.

Q4 product revenue of $265 million was up 3% year-over-year and accounted for approximately 45% of total revenue.

As François mentioned, software revenue grew 91% year-over-year for the second consecutive quarter.

Software represented approximately 31% of product revenue in Q4, up from approximately 27% in Q3 and from 17% in the year ago quarter.

We continue to experience strong uptake on our software solutions sold as ELAs and annual subscriptions.

The contribution from ELAs was up quarter-over-quarter and up substantially year-over-year.

I will take a moment to elaborate on the impact of the implementation of 606, which was a source of some discussion with investors last quarter.

Let me give you the punchline, though, which is that the adoption of 606 hardly impacted our year-over-year software revenue growth in Q4.

Let me explain why.

Under the modified retrospective approach to ASC 606, we are required to compare our 606 Q4 '19 results to what they would have been under 605.

In Q4, we estimate the implementation of 606 had a similar impact to Q3.

The 606 to 605 comparison is not meaningful for measuring our software growth because nearly all of our 2018 revenue came from perpetual licenses or other consumption models not impacted by 606.

In the year ago quarter, had 606 been in effect, the net impact to the software revenue would have been de minimis, slightly more than $100,000, which means our Q4 software growth rate using 606 in FY '19 compared to FY '18 would have been approximately 90%.

Said differently, our software revenue growth is being driven by new offerings and new consumption models and not an acceleration of an existing run rate of subscription revenue.

Moving on.

Systems revenue of $182 million made up approximately 69% of product revenue and was down 15% year-over-year as customers continued to accelerate their transition to software-based solutions.

Services revenue of $325 million grew 6% year-over-year and represented approximately 55% of total revenue.

On a regional basis in Q4, Americas delivered an exceptionally strong quarter with 11% revenue growth year-over-year and represented 59% of total revenue.

EMEA was down 3% and accounted for 23% of revenue while APAC was down 2% and accounted for 18% of revenue.

Looking at our bookings by vertical.

Enterprise customers represented 61% of product bookings and service providers accounted for 17%.

Our government business was very strong, representing 22% of product bookings, including 13% from U.S. Federal.

In Q4, we had 3 greater than 10% distributors: Ingram Micro, which accounted for 18% of total revenue; and Terasoft and Tech Data, each of which accounted for 10%.

Let's now discuss our FY Q4 '19 operating results.

GAAP gross margin in Q4 was 84.6%.

Non-GAAP gross margin was 86.3%.

GAAP operating expenses were $385 million.

Non-GAAP operating expenses were $317 million.

Non-GAAP operating expenses were higher than our expectations as a result of the higher sales commissions related to software sales.

Our GAAP operating margin in Q4 was 19.4%, and our non-GAAP operating margin was 32.6%.

Our GAAP effective tax rate for the quarter was 19.7%.

Our non-GAAP effective tax rate was 20%.

Turning to the balance sheet.

In Q4, we generated $206 million in cash flow from operations, up slightly from last year.

Cash and investments totaled approximately $1.3 billion at quarter end.

DSO was 49 days and capital expenditures for the quarter were $21 million, down sequentially as we completed the final phases of building out our new Downtown Seattle facility.

Deferred revenue increased 18% year-over-year to $1.2 billion.

Less than half the increase over the prior year quarter relates to the adoption of 606.

We ended the quarter with approximately 5,325 employees, up approximately 130 employees from Q3 reflecting our continued investment in growth areas, including sales and research and development.

In Q4, we did not repurchase any of our common stock.

We continue to view cash as a strategic asset for our future growth.

Though our primary focus with cash generation is augmenting our strong balance sheet and building a war chest for strategic purposes, we may opt to repurchase shares during any open trading window.

Let's briefly discuss our fiscal year results.

For the full year, total revenue grew 4% to $2.24 billion.

Product revenue of $986 million grew 3% from the prior year, and accounted for 44% of total revenue.

Within product revenue, software grew 60% while systems revenue declined 8%.

Services revenue of $1.26 billion grew approximately 5% during the year and represented 56% of total revenue.

GAAP net income for FY '19 was $427.7 million or $7.08 per share.

Non-GAAP net income was $626.3 million or $10.36 per share.

For FY '19, cash flow from operations totaled $748 million, down $13 million from FY '18, largely as a result of the NGINX acquisition.

Capital expenditures were $104 million.

Now let me share our guidance for fiscal Q1 of 2020.

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

We continue to make strong progress transitioning our business to a software-driven model.

We remain confident in our position in the market, and expect our growth will be driven by the growth of applications and increasing demand for our multicloud application services.

We also expect continued strong demand for our software solutions as subscription and ELA offerings.

With this in mind, we are targeting Q1 '20 revenue in the range of $560 million to $570 million.

We expect gross margins of approximately 86%.

We estimate operating expenses of $296 million to $308 million.

We anticipate our effective tax rate for Q1 will remain in the 21% to 22% range.

Our Q1 earnings target is $2.41 to $2.44 per share.

In the quarter, we expect share-based compensation expense of approximately $46 million and $4.6 million in amortization of purchased intangible assets.

Finally, as has been our practice, we want to provide you with high-level fiscal 2020 modeling assumptions.

First, we are tracking to our Horizon 1 outlook for mid-single-digit total revenue growth and anticipate a continuation of the trend we saw in the second half of FY '19 with customers accelerating the transition of their applications to software-based solutions.

On FY '20 operating metrics, we anticipate gross margins of approximately 86% for the year.

Following our typical seasonal pattern, we would expect operating margins to move down in Q2 from Q1 and then increase in the second half with full year results within the Horizon 1 range of 33% to 35%.

We expect FY '20 stock-based compensation in the range of $185 million to $195 million and capital expenditures in the range of $50 million to $70 million.

We expect to update our Horizon 2 outlook at our next Analyst and Investor Day, which we have scheduled for March 3, 2020, in New York.

Details will follow as we get closer to the date.

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

François?

Thank you, Frank.

I will speak to some of the business trends we are seeing, highlight some customer wins in the quarter and speak to why we think we are well positioned to capitalize on skyrocketing application growth before moving to Q&A.

But first, I want to highlight the partner news we announced today with Amazon Web Services.

We have signed a strategic collaboration agreement with AWS.

The agreement outlines specific areas of collaboration across our field sales, solution architecture and professional services team.

F5 will now have dedicated AWS solutions architect and professional services resources trained on F5's technical architecture and our application services across all product lines and geographic peers.

They will be designing F5 into their solutions for existing and new cloud-native customers.

Additionally, we have agreed to jointly collaborate on new offerings integrating F5 application services with AWS services, Control Tower, CloudFront and other core offerings.

We expect this will result in improved customer experience for those customers extending their existing workflows to AWS and for new cloud-native applications being deployed in public cloud.

We are excited with this next step in our partnership with AWS.

For our joint customers, our collaboration will reduce the complexities of securing their assets with a consistent security posture and policy management in hybrid cloud deployments.

Now let me turn to the fourth quarter and the tremendous progress we are making in transforming F5's business and driving software revenue growth.

Last quarter, we said that from our customer's perspective, it is clear that F5 has moved beyond a traditional ADC player.

This quarter's result provide another data point of our progress and highlight the fact that F5 is emerging as a leader in the rapidly expanding multicloud application services space.

Our customers increasingly want to consume more F5 service as a software and to securely deploy applications faster.

We have taken a number of steps to unlock this market demand.

First, we have created new consumption models making F5 services available in subscription and ELAs.

In doing so, we are reducing friction for both enterprise and service provider customers, ensuring easier software provisioning and reducing operating complexity.

As Frank mentioned, we continue to see strong subscription and ELA traction in Q4.

In some cases, we are seeing opportunities to expand our revenue opportunity with customers with whom we have already secured an ELA.

For instance, last quarter, we mentioned we have closed an ELA with a large next-generation mobile carrier in APAC with our 5G-ready NFV solutions would address their growing 4G mobile broadband consumer services.

I am pleased to announce today that the customer is Rakuten, and during Q4, we secured a second all-software use case with them for GI firewall.

Second, we are enabling more automation and orchestration on our platforms to enable faster application provisioning.

In a real-world example of customer impact, we are providing one of the world's leading converged video broadband and communication companies, a cloud-based disaster recovery solution for their mission-critical entertainment back-office support service.

In the case of power failure, a disaster recovery solution is activated, replicating the customer's back-office support service in AWS.

F5 BIG-IQ, the central management solution for BIG-IP, provides the functionality to automatically start F5 BIG-IP Virtual Edition in AWS when needed.

It also provides application and performance visibility of the activated disaster recovery system.

In addition, BIG-IQ is providing on-demand licenses for the BIG-IP virtual editions which are being consumed under an ELA to ensure cost-effective consumption-based licensing for the disaster recovery infrastructure.

Third, with NGINX, we are enabling application services consumption in native container environment.

As an example, during Q4, we secured a joint F5 NGINX win with an EMEA-based financial tech customer.

This customer was an existing F5 customer and also a longtime user of NGINX open source for application services in their microservices environment.

The customer's development team have built functionality on top of NGINX' open-source edition to achieve the level of functionality their business demanded.

As this scales, however, this do-it-yourself approach became difficult to manage.

The combined F5 and NGINX team worked together to demonstrate that standardizing on NGINX plus with software support will deliver better value for the customer's development and operations teams.

Fourth, we are extending all our security offerings to software form factors.

We continue to see strength in our Software Security business as customers tap into the efficiency and scale of the public cloud while utilizing F5 to secure their applications and maximize availability.

During Q4, for instance, a large credit union with well over 1 million members chose F5 to protect their apps as they extend to the public cloud.

The customer wanted the efficiency of the cloud along with a consistent set of application protection policies that matched their on-premise security.

They are fully integrating the F5 solution into a CI/CD pipeline, utilizing the F5 automation tool chain, BIG-IQ, and advanced security features in our Web Application Firewall.

Fifth and finally, we also are providing solutions specific to the software consumption needs of our service provider customers.

In a Q4 win with an EMEA-based service provider, for instance, we sold virtual Gi LAN capacity extensions with VNF Manager in a win that included systems, software, energy and professional services.

As a result of these actions and our customer's ability to operationalize and manage virtual infrastructures, we are also experiencing changes in our systems business.

What I would ask that you keep in mind as we work our way through this model transition is that F5 is different from traditional hardware data center vendors.

Our value proposition is and always has been in our software and application fluency.

As a result, the value we bring to our customers is not tied to the data center.

Rather, it moves with the application.

So as we continue to take steps to untether our software from [proper sale] hardware, we are capturing growth in new forms of consumption of our application services.

While we believe software use case are and will remain top of mind for customers, we do see systems demand in certain high-performance use cases with customers that want to control and manage end-to-end application delivery in certain key customer segments and in some emerging geographies.

As an example, during Q4, we worked with a state-owned real estate company in APAC that was looking to refresh F5 solutions that were approaching the end of support.

We initially viewed this as simple systems refresh opportunity.

However, we learned the customer was also looking to enhance and improve their current web solution.

They were also planning an upgrade to comply with the application infrastructure architecture standard, had issues with their single sign-on solution, and software from an inefficient security chain.

We won the deal with a systems-based solution that combined our local traffic manager with our application security manager, SSL orchestration and Access Policy Manager.

Before I move on from Q4, let me also provide a brief update on NGINX.

In our first full quarter as a united F5 NGINX team, we continue to drive our value creation plan at a rapid pace.

Our first combined solution, a controller that builds on the already successful NGINX controller with enhanced enterprise-class features, is on plan for release by the end of January 2020.

We expect this converged solution will be an accelerator for our NGINX business, expanding both the addressable market and potential [sizes] by expanding a broader set of use cases across DevOps and Super-NetOps customer personas.

F5 and NGINX sales teams are coming together well with tighter go-to-market teamwork and collaboration, which we expect will only accelerate in 2020.

I will spend just a few minutes speaking to how we see our opportunity unfolding in fiscal year 2020 and beyond before we move to Q&A.

We are focused on expanding our leadership in multicloud application services, on driving continued software growth on BIG-IP Virtual Edition, as well as on NGINX and our Cloud Services SaaS platform.

At the same time, we are working to forge [New World's] go-to-market capability, to expand our reach to DevOps, to strengthen enterprise competences on supporting and growing a subscription business and to scale our public cloud partnerships.

And we believe the size of our opportunity is growing.

At our March 2018 Analyst and Investor Day, we said F5 growth opportunity was intrinsically linked to global application growth.

ISV estimates there were more than 340 million enterprise application workloads globally in 2018 and forecast that number will grow to approximately 1.8 billion by 2023.

At the same time, the number of applications is growing nearly 5x.

The complexity of deploying, managing and securing these applications is increasing.

Enterprises are embracing new highly distributed architectures and multicloud environments.

Simultaneously, the risk of cyber-attacks and security threats is increasing with the majority of threats targeting applications or the identity of the person accessing that application.

This set of challenges is F5's opportunity.

In an increasingly fast-moving and complex environment, we are in a unique position to actually reduce the complexity of deploying applications across multicloud environments to help our customers develop, deploy and scale their business-driving obligations significantly faster with substantial cost savings on the infrastructure required to support, manage and secure those obligations.

Perhaps most importantly, we are approaching this challenge with a customer-focused mindset.

Let me elaborate.

Over the course of 2019, I have had the opportunity to talk to customers around the globe that manage their application capital well, a strategic asset similar to how we manage physical and human capital.

They all share 2 common attributes.

They consistently deliver a higher volume and faster velocity of code to user.

What do I mean by that?

Developers are core to building applications.

They write the code that is the foundation of applications, the business logic, back-end components and customer-facing interfaces.

However, building a great application is only half the journey.

The other half is delivering that application, that code all the way to the mobile device, machine or browser that an end customer uses to access the application.

The world's most competitive companies have mastered how to push code from development into production with velocity at high volume.

They do it in minutes.

Good companies do it in days.

For most, however, it still takes weeks.

And F5 can change that.

For example, we recently helped a large banking customer reduce the amount of time it takes to deliver code to users from 23 days down to just 6 minutes.

With F5's solution, this customer is driving new revenue-generating services and powering developers to be more productive and saving time and money on the infrastructure needed to support their application capital.

Our customers can achieve results like this because we deliver the most comprehensive set of technologies and services available, and we remove friction from the code to user delivery chain.

So how is this different from other approaches?

Most vendors are trying to vertically integrate application services by tightly coupling the infrastructure and a siloed set of application services.

We believe application services need to be infrastructure-agnostic, spanning from code to user.

Ours is the only portfolio of application services that stretches horizontally from the servers that house developer code all the way out to the devices that our customers use.

In other words, we are abstracting the application services from the infrastructure and making it possible for our customers' applications to run anywhere -- cloud, container, legacy -- with access to a consistent set of application services.

We believe this horizontal approach better serves our customers and provides a sustainable differentiation in the market.

During Q4, we shared this vision with more than 75 of our most important customers and 90 of our key partners at Aspire, our premier customer engagement forum hosted in Seattle.

The event brought 550 attendees to our new customer engagement center, including customers from every theater and every industry.

The benefit of abstracting application services from network infrastructure resonated very well with attendees, who received custom demos and tailored sessions showing how F5 can help them move faster and more cost-effectively.

Their reaction was very positive, and we're looking forward to sharing this perspective with all of our customers in 2020.

In summary, we are entering 2020 in a position of strength.

We build on our market-leading ADC and security portfolio with BIG-IP, NGINX, F5 Cloud Services, Silverline and other investments and continue to add new application services.

We have added technologies that either provide or power app servers, Web servers, container networking, API solutions, DNS, Distributed Denial of Service capabilities and content delivery networks.

We are leveraging best-in-class application management and security services.

A sticky base of thousands of enterprise customers and realtime intelligence and actions.

And we will continue to enhance our ability to make applications wherever they are to specified multicloud complexity for our customers and to expand the breadth of our application services, including extending security services across all our platforms.

In closing, my thanks to the entire F5 team for driving a great quarter and year.

Your grit, determination and flexibility is behind a significant transformation of our business that we believe will bring long-term returns to our customers and shareholders.

My thanks also to our partners, our customers and our shareholders for joining us on our journey.

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

(Operator Instructions) And our first question is from Sami Badri with Credit Suisse.

So you commented on the strength of software and the dynamics that you expect in 2020.

Just to give us a little bit more of an idea on how we should be modeling systems growth, would you say that the dynamics and the growth rates that we've seen in the last 2 quarters in Systems growth should also be extended through FY '20 with the Software dynamics maintained?

Sami, thanks for the question.

So what you saw in the second half of 2020 is an acceleration in the decline of the Systems business and also a very significant acceleration in our Software business.

I think that dynamic generally is going to continue in 2020.

So relative to what we would've expected a year ago, we think we're ahead of plan on our transition, and that the software growth is going to be higher than what we thought.

And the systems decline is also going to be factored in what we would've thought in the past.

That's driven by a combination of things.

On the one hand, customers -- we're seeing customers that have matured in their ability to consume application services and software.

A number of customer have software-first policies, have policies to leverage multicloud.

They have more operational maturity around virtualization, and we're seeing that both in enterprise and the service provider segment now.

So there's a demand pull from the market.

And there are also a number of things that we have done to accelerate that transition by enabling customers to consume our BIG-IP software in new consumption formats, specifically subscription and enterprise license agreements, a lot of work with public cloud marketplaces.

We've done things like automation and orchestration that allowed them to deploy applications faster in software.

We've put a lot of our software in security and software consumption factors.

And we've also done a lot of work to help service providers move to software.

So when you combine a lot of the things that we have done as well as the demand from the market, you're going to see that trend continue.

And for us, it's good news because we feel that our strategic pieces is intact, and we are ahead of our plan on our transition.

Got it.

And then the second question I had is if you were to categorize the movements or, I guess, you could say the growth and strength in Software and Systems across your customer types, across enterprise, SPs and government, which one of these buckets is accelerating the systems decline versus which one of these buckets is actually accelerating the software adoption growth, right, just so we can get an idea on which customers are driving these changes.

I think all 3 have -- Sami, I think all 3 have both trend to a degree, but I'll take them separately.

So in the enterprise, we -- I think the transition toward Software started in the enterprise earlier than the other 2 segments that you mentioned.

And that trend is only accelerating for the reasons I mentioned around operational maturity, ability to operationalize virtualization technologies and also the freedom of consumption that we have given them.

The -- in the Service Provider segment, I would say, it's only in the last couple of quarters that we -- our customers have spoken about and is the -- so a number of years, but we are now seeing them moving part to implement the virtualization technology.

In part with -- in combination with 5G or in getting ready for 5G architectures, we're seeing more of our service provider customers adopt software architectures.

I mentioned in the script, one of the customers we won, Rakuten, who are building essentially a telco -- a next-gen telco infrastructure that's 100% virtual.

And so there, I think that's one of the spectrum, but we're seeing a number of carriers move in that direction.

And then I would say in the government, the transition is also happening but at a slower pace relative to the other 2 segments.

Got it.

And then my last question for you is regarding the cash pile and war chest.

Could you just give us an idea on specifically what you're looking for?

You mentioned that the security offerings are now going to be following software form factors.

Is that where you're going to spend the majority of your time to consider bolstering the business or using the war chest?

Or could you just give us a better idea of what exactly you're looking for as opportunities?

No.

Sami, I would -- the way I'd characterize it for you is we want to become the best application services platform in the industry.

And I think the way to look at it is, if you look at everything that exists between an application and the users of that application, there is a set of services that are in that chain that include things like load balancing and security and firewalls and app servers and Web servers.

We have significantly broadened our presence in the code to customer chain with the acquisition of NGINX.

And our strategy is essentially to own that horizontal chain and provide the best application services that enhance this customer experience for uses of an application.

And so when we look at -- and that's kind of different than others who are fast pursuing more of a vertical approach where they are tied to a single silo of infrastructure.

We want to be 100% infrastructure agnostic, enable those application services for any app anywhere, regardless of how it's built and regardless of where it's deployed.

And so in the context of that horizontal strategy, we're looking at opportunities to run our portfolio organically or inorganically anywhere in that chain from code to customer.

So security is, of course, an important component of that, but it's not the only one.

Your next question is from James Fish with Piper Jaffray.

Congrats on a great quarter here.

Frank, more for you.

You called out large ELAs being up year-over-year and sequentially.

Can you just give a sense as to how much ELAs got booked and virtual versus appliance?

Or any sense of how big the ELA business is as a percentage now within F5 as it seems like it's becoming more material over the last few quarters?

Sure.

And James, thanks so much for your congratulations.

We also thought it was a great quarter.

We don't quantify the effects of ELA.

And I did say that we were up in terms of dollars for 4 sequential quarters, and the deal cap was also up over a broader base, and we're seeing our [NFTs] up as well.

And so we're really, really happy with the way ELAs are trending and that they're unlocking the spend that we see.

We see a very robust pipeline going forward because we've really only scratched the surface on the opportunity set within our customer base.

Unfortunately, I'm not going to quantify the amount of ELAs, but I will say that it has been a positive trend for us.

Got it.

And then you guys have talked about the F5 NGINX controller kind of coming at year-end.

It sounds like it actually got pushed a month.

But also, didn't really hear too much around sort of the WAF as a service and global load balancer as a service.

Any sense of the timing around those and how you guys are thinking about it for 2020?

Jim, I'll take that one.

No, the controller -- the combined controller with NGINX was [not for sale a month].

I think we said January when we last spoke, and we're well on track to be able to deliver on that.

We're pretty excited about it because it enhances the addressable market for NGINX in the number of [ports sold] inside of the enterprise -- the large enterprises.

As it relates to -- your other question, I think, was related to F5 Cloud Services, which is our SaaS offering.

And as you know, we have released our DNS offering a few months ago.

We just released earlier this month our global server load balancing as a service offering, and we're seeing strong interest in that.

And then Web Application Firewall as a service, WAF as a service is next on our road map, and that should happen before the end of the calendar year.

Your next question is from Rod Hall with Goldman Sachs.

This is Ashwin on behalf of Rod.

I was just wondering if you could comment on the sustainability of the strength in the U.S. Federal vertical and how you are thinking about that in fiscal '20.

And another question related to competitive dynamics.

Can you comment on any changes you are seeing in the competitive landscape?

Any color on win rates or anything you can give us post the acquisition -- completion of VMware Avi Networks acquisition would be great?

Just -- Ashwin, can you repeat the second part of the question?

The first part was on the federal government but on the first -- the second part.

The second was really on the competitive landscape following the acquisition of VMware Avi Networks, can you comment on any changes in win rates or anything there will be helpful?

Yes.

Ashwin, I'll take the second part on the competitive landscape, and then Chad will take the question on the federal government and the sustainability of our strength there.

So essentially, we haven't seen a change in the competitive landscape after the acquisition of VMware -- of Avi, sorry, by VMware.

On the last call, I mentioned to you, we were not seeing Avi in very many deals.

And where we see them, we have been pretty happy and comfortable with our win rate.

And so essentially, that hasn't changed.

I would expect it to change with the presence and distribution that VMware has around the world and to see them more over time, especially in customers that have gone all in on NFX and really are tied to that infrastructure.

But we don't see that as a really large proportion of the market so more to come on that, but so far, no change.

Perfect.

Ashwin, this is Chad Whalen.

Regarding the strength of the Fed business in 2020.

As we did in our release, Federal performance in Q4 was fantastic.

Much of this is sustainable for a very simple reason: we're built into very large programs across the federal government base from 3-letter agencies all the way through the Department of Defense.

And so for 2020, we're planning for a very robust year in the federal government space as well built upon much of what we've done over the last number of years within this -- with this -- excuse me, within this segment driving some of the key tenets within our security portfolio and some of the needs that are unique to the federal government.

Your next question is from Tim Long with Barclays.

Could you talk a little bit -- 2 questions from me also.

First, the new AWS partnership sounds like a nice expansion.

Can you talk a little bit about the timing and when you think that could materially pick up some of the cloud businesses for you and are there any other potential public cloud partnerships or expansions that we should expect to see?

And then the second, I wanted to follow back up on the Systems business.

Obviously, there's this transition going on.

Just curious, is this an area where we're going to need some kind of refresh for some of the customers?

And if not, given that it's becoming a smaller piece, from an investment standpoint, does this change the investment profile of the overall company where maybe there's a little less R&D or less sales push on the hardware side, and maybe that means some overall better leverage on OpEx for the entire business?

Thank you, Tim.

So let me start with the -- your questions on AWS and the public cloud.

Just for context, Tim, our software business, as you see, has accelerated very significantly in 2019.

And if you look at the second half of the year where our software grew about 90% year-on-year, public cloud business has actually grown faster than that all year.

So it has continued to grow because of the integrations we had already done with public cloud providers, the availability of our solutions in marketplaces and also enabling our customers to put their license into public cloud.

And so as a result of all this, our Public Cloud business has become a meaningful portion of our overall -- our Software business.

Now the partnership with AWS takes that to a new level because we have been meeting AWS in the market where customers want AWS and want F5 and [Access] to get together and help them move forward with their Public Cloud initiative.

But now we're going to have a number of AWS solution architects and professional services, people who are trained on F5 and are designing in F5 into their architectures and their solutions when they are engaging customers.

And AWS, obviously, has a lot more resources than we do.

So we look at that as a multicloud effect of our own resources in the market to design us in for customers that want to leverage Public Cloud infrastructure.

So we're very excited about that, and we're also very excited about the collaboration we've agreed with them on the product side integrating things like our WAF into platforms to complement their CDN with a security solution to enable them to better compete with the likes of Akamai and other integrations with a Control Tower, which is really how customers manage and deploy their applications in Public Cloud.

So it's just going to give us an expanding surface into the Public Cloud and more visibility.

When that will impact our numbers, I think, overall, this is going to provide further acceleration to an already fast-growing Public Cloud business.

And the specific impact of SaaS partnership, I think, is more of a second half of 2020 through 2021 but to be -- could be significant.

On the second part of your question, which is on the hardware decline and what does that mean for our investments and potentially operating leverage, we're going to continue to manage the investment overall in hardware.

We have a number of platforms that are in development that are going to come to market in the next few quarters.

But overall, if you look at where we're at in terms of what we've guided to on operating profit for this year, we said we will do about 33% to 35% for the year, and we expect to be in that range this year.

And then at our analyst and investor meeting, we will give you an update on what we think is going to happen at Horizon 2, which is '21/'22.

Your next question is from Paul Silverstein with Cowen.

Got some clarifications and a couple of questions.

First off, could you all give us the NGINX contribution?

I know that their revenue was small at the time you acquired them, but can you provide a number for NGINX?

Paul, we did not.

I mean I told you in the call last quarter that we thought that it would be approximately $8 million.

It was slightly more than that, ever so slightly, but it was spot on, and when you take a look at the inorganic and organic growth, it was almost the exact same as we had last quarter.

All right.

And I trust that $8 million is all software or primarily software?

No.

Actually, there's a split between software and services.

The software component was approximately $6 million, and the services was just slightly over $2 million.

All right.

I appreciate that.

That's helpful.

Now let me ask my question relative to that.

So your hardware was down 15% following an 11% decline.

And you obviously made that out with software and then some.

And we all know that software pricing -- or at least I think software pricing, maybe I shouldn't be so cavalier about it, but that software pricing is well below hardware pricing.

I trust that's a given before I ask the real question.

No.

I don't think that's a given, Paul.

But one of the (inaudible)

There goes my [French].

There goes my French . I guess what I'm trying to decipher looking forward is normally when one sees hardware decline of this magnitude, I would expect that to swamp your ability to transition the model at least over a transitionary phase.

But you just put up growth.

And I guess from a big-picture perspective, I'm trying to decipher as we look forward what's going on -- and I've listened attentively to your call.

You said a lot of things on a lot of trends, but that -- this is the first quarter in the Americas we're seeing 11% year-over-year growth, 14% sequential.

You haven't had a quarter of that type of growth in the Americas region in the U.S. You'd have to go back about 3 years.

At the same time, you cited macro conditions were depressing for the decline in EMEA, which had been strong up until beginning of this year, and APAC, which has been more mixed.

So again, first of all, if I could ask you to take a step back and appreciate -- you've given us a lot of detailed information on the call, but from a big-picture perspective, when you look at the regional trends, you look at the hardware to software mix before I ask about margins, what's going on from a revenue perspective?

The growth we saw in the Americas, is that the new norm?

Yes, Paul.

I appreciate there is -- there are a lot of signals there that you're trying to make sense of.

So let's talk about hardware and software first, and then let's talk a little bit about geography.

And here -- I mean I think, Paul, the reason I'd say it's (inaudible) that the software price per unit is lower than the hardware price per unit is because it really depends on the use case, the type of application, where it's deployed, what bundle of application services are used for that application.

And in some cases, yes, it's lower.

But there are a lot of cases where the software deal ends up being larger than the hardware deal would have been because the [company] can deploy more of it and more functional.

François, I apologize for the interruption, but this is exactly where I was going with this.

I trust the reconciliation that unit volume, whether literally measured by units or measured by the use case, that you're making up for the degradation on a like-for-like pricing basis the differential between hardware and software, and predating your arrival at F5, F5 consistently forever would cite virtual editions at 80% of the price point of the hardware.

I was assuming that hadn't changed, or if anything, it had changed for the worse not for the better.

But assuming that's still the case, to the point you just made, I trust these deals are getting bigger in scope, and that's why there's a positive offset in the revenue.

Yes.

Yes.

I think you're correct on both counts.

So it is still the case on your price comparison of VE versus hardware.

But in terms of the margin dollars to F5, that nets out to being about the same.

If you -- just pure functionality, software versus hardware, exactly the same functionality.

What you said about the 70% to 80% versus 100% of hardware for the price per unit, it's true.

But what happens when we are in -- when we look to software consumption form factor is that it's easier for us to expand our role with the customer because they have more freedom to deploy their technology.

They can add use cases faster.

They can replicate the solution in multiple environments.

And so the overall consumption becomes larger.

Now if you look at the -- the numbers are important.

If you look at our fiscal year 2018, our hardware only declined 4%, but our product revenue for the full year was flat, 0% growth.

If you look at 2019, our [hardware] declined 8% but total product revenue was plus 3%.

So you have kind of several quarters of us showing that the Software growth is more than offsetting the Hardware decline, and that's because our software story elevates our relevance with customers and gives us an opportunity to expand our role, and I give you some examples in the script, the Rakuten deal I mentioned in Japan is a good example where we did a very large software deal with them, and we came back 3 months later and already expanded that with more kind of multimillion dollar software opportunity because of the speed of consumption and the number of use cases we're addressing.

So that's our hardware, software [story].

I'll touch a little bit on geography to your question.

I think we have seen -- EMEA, I think we continue to see micro uncertainty in Europe, and I don't see that changing in the first half of 2020 for a number of reasons that Brexit is a part of it and, generally, I think Continental Europe we're seeing just Microsoft [met there].

In North America, we had a very strong quarter in the Federal government.

We had a softer quarter in financial services, and I would expect that we see better performance from financial services in the first half of 2020.

And so generally, I expect North America to be healthy going into 2020.

All right.

Can I ask you a quick question on margins?

Your services have consistently been 87% plus/minus 30 basis points over the past 5 quarters.

Your product margin was just up over 85% following almost 84% last quarter from 82%, 83% in the 9 previous quarters.

I trust the improvement's driven by the shift to software from hardware, and I trust that trend should continue.

That's right, Paul.

Your next question is from Alex Kurtz with KeyBanc Capital.

Just a clarification then a question.

The long-term deferred, I think, was strong in the quarter.

Just kind of what was the dynamic in short and long term?

And then, François, just kind of following up on Paul's question around kind of share of wallet or how you're increasing use case within existing customers.

So how does -- where are the applications or use cases at?

When you transition to software, you make it more easily consumable that you're capturing, right, with an existing account.

Like what's that bell curve type of outcome that you're seeing right now?

Sure.

So, Alex, I think on the long-term deferred, a lot of that was driven by the growth of ELAs and some unbilled receivables.

And so that's why you saw the strength in long-term deferred revenue.

And then Alex, your second question is on the types of use cases that we're seeing?

Yes.

When you've transitioned most of your portfolio to software, you're talking about incremental use cases that are allowing you to grow your share of wallet.

So above and beyond the traditional ADC, like what are you seeing in these bigger software deals that are driving the bigger outcomes?

So Alex, 2 things.

Number one, you might see a deal in hardware that is load balancing only.

And then when we're in software because it's kind of natural for customers to consolidate multiple software modules, we will do load balancing DNS less and other capabilities.

So you're adding more capabilities to the deal.

But the other factor also is that when we're in software, a customer has an ability to deploy that [markup] in their data center, they'll deploy it in a public cloud, they'll deploy it in multiple public clouds, sometimes in private cloud.

So you're seeing more kind of replication of a virtual instance of F5.

And then the third factor that explains our opportunities in software is that the Public Cloud model for security is a shared security model where the Public Cloud provider secures the neighborhood and the customer, the enterprise has to secure their home.

And by definition, that's an important function for our customers to add more security to the software in the Public Cloud.

So as a result of that, our security attach rates in software use cases that are deployed in Public Cloud is much higher.

In fact, it's double the security attach rate in on-prem.

So those are 3 factors that are driving expansion of the opportunities in software.

Ladies and gentlemen, we do have time for one last question.

The last question is from Simon Leopold with Raymond James.

This is Victor Chiu in for Simon Leopold.

Can you tell by your estimation what portion of the ADC market has gone to the Public Cloud and what your view is on the trajectory and the rate of continued adoption?

And I guess off of that, of your existing customers that have migrated at least some portion of their workloads, what portion continues to utilize F5 solutions there?

What was the second part of the question, Victor?

Of your existing customers that have migrated at least some portion of their workloads, what portion of then do you expect continued or are continuing to utilize F5 solutions?

I'll take the second part of your question first, and then I'll come to the first part.

Generally, Victor, customers who are on F5 on-prem will migrate to the Public Cloud, the majority of them are migrating with F5.

And that's because it's a lot easier to do that than to go ahead and -- if you don't want to have to refactor an application, it's a lot easier to migrate with F5 than not.

And that's one of the benefits [for them].

You have also the partnership with [Optum].

It allows these migrations to happen a lot faster.

But the net of it is the vast majority of our customers were on F5, still on F5 in the public cloud.

Yes.

And Victor, this is Kara.

With regard to your first question, the question was about roughly what share of the ADC market do we see having moved to the Public Cloud.

I think that's what you asked.

What we actually see as these applications start getting lit up in Public Cloud is an expansion in terms of the use cases for ADC-like technology.

So what has typically been bucketed into the ADC market has the things that include load balancing.

There's parts of application security and other things.

Those capabilities are getting lit up in Public Cloud either through the Public Cloud-native providers or through third-party providers like F5.

And in many cases, those applications that are there are oftentimes net new cloud-native applications that are taking advantage of those services.

So that has been an expansion of the TAM for that market.

Right.

And are there any headwinds competing with you now in the Public Cloud alternative solutions, guys like Amazon?

Well, when you talk from the strategic agreement, we think there's a lot more synergy between our 2 companies and a lot more partnership opportunity than actual competition.

And in fact, one of the big benefits that F5 brings to this is F5 has been the go-to ADC solution provider for our enterprise customers for their most important applications.

Many of those most important applications are still sitting on-prem.

And they're looking at numerous Public Cloud vendors for selection for their new workloads or for modernizing their old applications.

In the case of the new workloads, they're finding use cases that apply for the Public Cloud-native capabilities as well as use cases that apply for vendors like F5, especially where they value that multicloud story.

And for the modernization of their old applications, what we're finding is that our customers really want to move those applications and modernize them with F5 because it gives them an easier path into the Public Cloud.

Ladies and gentlemen, a replay of today's call will be made available in approximately 2 hours and will be accessible until November 6 at midnight Eastern.

To access the replay, you can dial (800) 585-8367 and reference conference ID 8378996.

Thank you.

This concludes today's conference call.

Thank you for your participation, and you may now disconnect.