F5, Inc.
Q3 2016 Earnings Call Transcript

Published: 21 Jul 2016

[Operator:]

Good afternoon and welcome to the F5 Networks Third Quarter and Fiscal 2016 Financial Results Conference Call. At this time all parties will be able to listen only until the question-and-answer portion. Also, today's conference is being recorded. If anyone has any objections, please disconnect at this time. I'd now like to turn the call over to Mr. John Eldridge, Director of Investor Relations. Sir, you may begin.

[John Eldridge:]

Thank you, Sam. Welcome, everyone, to our conference call for the third quarter of fiscal 2016. John McAdam, President and CEO, and Andy Reinland, Executive VP and CFO, will be the speakers on today's call. Other members of our exec team are also on hand to answer questions following John and Andy's prepared comments. If you have any follow-up questions after the call, please direct them to me at 206-272-6571. A copy of today's press release is available on our website, F5.com. In addition, you can access an archived version of today's live webcast from the events calendar page of our website through October 26 from 4

[Andy Reinland:]

Thank you, John. F5 delivered solid revenue results and strong profitability in the third quarter of fiscal 2016. Revenue of $496.5 million grew 3% sequentially, and 3% year-over-year and was in the upper end of our $490 million to $500 million guided range. GAAP EPS of $1.37 per share was above our guidance of $1.29 to $1.32 per share. Non-GAAP EPS of $1.81 per share also exceeded our guided range of $1.77 to $1.80 per share. Product revenue of $231.4 million, up 3% sequentially and down 7% year-over-year, represented 47% of total revenue. Service revenue of $265.2 million increased 3% sequentially and 13% year-over-year, and accounted for 53% of total revenue. Americas accounted for 56% of total revenue during the quarter, EMEA contributed 24%, APAC 15%, and Japan 5%. US revenue was down slightly year-over-year, reflecting relatively weak telco spending, and EMEA was down 1%, as a result of softer than expected UK sales. By contrast, APAC revenue grew 20%, and Japan revenue was up 15% from the third quarter of last year. Enterprise customers represented 64% of total sales during the quarter. Service providers accounted for 21%, and government sales were 15%, including 6% of total sales from US Federal. In Q3, we had three greater than 10% distributors

[John McAdam:]

Thanks, Andy, and good afternoon, everyone. Overall, I was very pleased with F5 team's fiscal Q3 performance. We delivered year-over-year revenue growth with strong profitability, operating margins and cash flow, in what continues to be a relatively challenging business environment. From a sales perspective, both Japan and our Asia-Pacific regions delivered double-digit year-over-year sales bookings growth. Sales bookings in our Americas regions were down year-over-year compared to a strong Americas booking quarter in Q3 fiscal 2015. We experienced softness in the service provider vertical, especially with some of the Tier 1 telco operators. However, the Americas sales results were above our internal forecast, and I was pleased with the progress we are seeing in overall sales execution in the region. Sales bookings in EMEA were also down year-over-year, driven by weaker than expected results in the UK. Once again, our services business continues to deliver strong results and excellent profitability, with year-over-year revenue growth of 13% and deferred revenue growth of 15%. Overall, software revenues were very solid in Q3, accounting for 38% of overall product revenues with excellent growth in software sales, and to public and hybrid cloud architectures. Software revenues include VE versions of TMOS and VE solution modules, as well as solution modules shipped on our appliances and our VIPRION range of products. Security sales were up sequentially over Q2, with a number of excellent security wins across the entire portfolio of our security solutions. For example, a large financial services company used F5's SSL intercept capabilities to provide visibility to encrypted outbound traffic, and protect against a collection of both known and unknown advanced attacks. This solution included service chaining of other vendors' attack detection capabilities, including FireEye and Palo Alto Networks, and further demonstrated our openness and integration capabilities. Another excellent security win, driven by the Internet of Things trend, involves a large Fortune 500 Company leveraging our TCP optimization and WAF capabilities to scale and secure a 10,000-plus IoT deployment. A large bank in EMEA acquired our best BIG-IT bundle to provide service consolidation of several critical functions

[Operator:]

Thank you. And we will now begin the question-and-answer session. [Operator Instructions] And our first question is from Rod Hall with JPMorgan. Your line is now open..

[Unidentified Analyst:]

Hi. This is Arkay on behalf of Rod. Thanks for taking my question. Could you expand some more on your commentary on the macro and enterprise spending, and on what you are seeing in the US and globally, and maybe talk about the kind of linearity you saw through the quarter?

[John McAdam:]

Yes, in terms of the comments I made on the macro, it's really straightforward, nothing in depth in terms of what I was coming to. You've got things like Brexit happening over in the UK, you've got all of the weird stuff that's happening worldwide in places like Turkey. Frankly, although results seem to be going well this quarter, we are happy with ours, they're still low percentage versus what the used to be five or six years ago. It's really that. And I think just given that scenario we feel that we should be reasonably cautious, when we look at the forecast that we get from our sales organization and how we think the business is going. In terms of the linearity, it was pretty smooth, really, no surprises. We didn't see any - it was really normal linearity, which for us, we like that a lot. And that was almost on a weekly basis, as well, right throughout the quarter.

[Unidentified Analyst:]

Okay, thanks. And could you also comment on the rumor of any interest by Thoma Bravo to acquire your company, and whether you'd be interested in a bid?

[John McAdam:]

I'm glad you were the first one to ask, because you're first on the call. I mean, I think you're going to know the answer to this question. We do not comment whatsoever on any rumors or anything like that and that will be the same right throughout the call.

[Unidentified Analyst:]

Okay. Thanks.

[Operator:]

Thank you. And our next question is from Alex Henderson with Needham. Your line is now open.

[Alex Henderson:]

Great. Thanks. I was hoping you could give me just a data point. What was the exact ending share count, and while you're looking that up, I was hoping to ask a question. The product refresh timing is a little unusual, relative to your fiscal year-end. Normally, you have a seasonally softer first quarter fiscal, which is the December quarter. Would you think that given the product refresh, that would give you a little bit more heft sequentially into that December quarter? I know you don't want to forecast more than one quarter at a time. But generally speaking, would you expect that to be a little bit more sequential heft into the first quarter or should we just use the standard seasonality parameters?

[John McAdam:]

Yes, it's really too soon to answer that second question. Alex, this is John. Obviously, we feel good about the refresh and we feel good at the opportunity, but we've not seen enough data yet on that, to either be negative or positive. And as you mentioned, we don't tend to forecast outside the quarter. So I'm going to pass on that one.

[Alex Henderson:]

Let me ask another one then. Can you give us some clarity on the financial vertical? I know you stopped breaking it out. But obviously been a lot of contusions to the finance vertical, particularly in Europe, but also in the US. Can you give us any sense of what's going on in that vertical?

[Andy Reinland:]

Just in terms of our execution there, I'd say is pretty consistent. As you said, we don't break it out anymore. But I wouldn't highlight anything.

[John McAdam:]

This is John. We haven't seen any major shifts of any significance in the verticals.

[Alex Henderson:]

Okay, just the share count then. Thanks.

[Andy Reinland:]

Yes, so the ending share count was 66.2 million.

[Alex Henderson:]

Thank you.

[Operator:]

Thank you. And our next question is from Brian White with Drexel. Your line is now open.

[Brian White:]

John, you said the service provider spending in the US was a little soft in the June quarter. Do you expect that to come back in the September quarter? And if you could talk a little bit about NFV, what F5 is doing in that market, the trends that you're seeing, as it's starting to take off? That would be great, thank you.

[John McAdam:]

Yes, in terms of looking at next quarter, I mean, first of all, I'm going to make an obvious statement, and the telco market tends to be lumpy, and I think that's always going to be the case. And with our telco business in particular, it's mostly project-driven as well, which goes in line with that lumpiness. And obviously, we're hoping that the 100-gig has an impact and that's why we called that out. But we are not - we don't forecast by vertical. So I'm not going to say anything about what we expect next quarter, but it's still going to be an important vertical for us with 100-gig. In terms of NFV, I think we're in a really good position for NFV. Everything that - NFV by definition is obviously software biased completely. And all our products, all our solutions can be delivered in a software only way, and as you heard, the other thing we're doing is massive work on orchestration and management, and that's also critical in an NFV space. And then Karl, you might want to talk about the performance of the TMOS VE that we're looking at, as well.

[Karl Triebes:]

Right. Just a few comments, Brian. One, just to go back on orchestration and management, we are also big contributors on OpenStack, which is a big driver for these NFV-based applications. And we see traction in NFV across our entire product line; they're adopting all the different modules as part of that, in these software environments. In terms of performance, we did demonstrate at Mobile World Congress in Barcelona last February, and we are doing this with Intel, essentially a very early prototype version of what will become 100-gig version of our Virtual Edition software. But in the interim, we'll be releasing, towards the end of the year, a 40-gig equivalent version of that. We're moving on to the much higher performance, and in our internal testing right now, we're achieving really good results, with the performance. And so we expect by the end of the year to be shipping that.

[John McAdam:]

And we have seen $1 million-plus project wins that are NFV-based.

[Brian White:]

Great. Thank you.

[Operator:]

Thank you. Our next question is from Alex Kurtz with Pacific Crest. Your line is now open.

[Alex Kurtz:]

Yes. Thanks, guys for taking the question. John, how would you characterize the larger transactions over the last couple quarters, and especially in June here, across the different verticals? And the deals that are including more security, sort of at the higher end, above a couple million dollars?

[John McAdam:]

Well, to do it by actual function is a little bit different, I haven't got that on the top of my head. But generally, we look at this fiscal, we saw pretty good growth in the $1 million-plus transactions in Q1 and Q2. To be frank, that actually fell off a little bit in Q3, and we're still happy with the result, but we didn't see quite as many. So hopefully we'll see that return in Q4.

[Alex Kurtz:]

Thanks.

[Operator:]

Thank you. Our next question is from Erik Suppiger with JMP. Your line is now open.

[Erik Suppiger:]

Yes. Thanks for the question – for taking the question. So you mentioned that Brexit appeared to have some impact. I'm just curious, there is been some differences in the way some of the vendors have seen that, the impact from that. In some cases, there is been business actually pulled into the June quarter in light of currency concerns for future quarters. Can you just give us a little bit of some color around how that played out at the end of the quarter, and how that was negative on your results?

[John McAdam:]

Yes, and it's always really, really difficult to point to Brexit, and say that's why we had a certain result in the UK in particular. And let me, before I go more into the question, just to reiterate that EMEA, I mentioned that EMEA sales were down year-over-year and they had a great track record up until that. But that was EMEA, UK actually was down fairly significantly. We think that's probably Brexit-related, but remember by Brexit-related that could be currency-related, it could be a number of things. We did have one example, and it's only one that I know of, of a customer actually placing a purchase order, halving the purchase order, and then deciding that they wanted to take it back completely. That was all June. We didn't ship it or take revenue on it or anything like that. It was just a purchase order. I'm not implying we extrapolate across the whole of that UK market, but that did happen. So we think there was some impact, and time will tell now, as you look forward to this quarter as well, that was just a sudden impact, given the result or it's going to be a longer impact. It is something you need to take into consideration.

[Erik Suppiger:]

Okay. Thank you.

[Operator:]

Thank you. Our next question is from Rohit Chopra with Buckingham Research. Your line is now open.

[Rohit Chopra:]

Thanks very much guys. I just wanted to ask you a little bit about federal, it was down sequentially, last year same period, it was up. Just wanted to see if there's anything there, maybe more competition? Spending seems to be roughly the same over there. And then maybe you could talk a bit about competition if you don't mind, just what's happening in the space, and what you are seeing in both the ADC and also on the security side, with your new products coming out?

[Andy Reinland:]

Yes, so on the federal space, I mean, really the most prominent quarter for us generally is the upcoming quarter, with federal. Other than that, it can be lumpy, like telco, it just depends on when the projects fall and we can recognize revenue. So I wouldn't say there is anything to read into that movement at all.

[John McAdam:]

And on the competition, no big changes from last quarter or the quarter before. Obviously, we are coming out with a lot of products that's going to make us more competitive. But in the ADC space, it remains mainly Citrix, don't see any change in win rate, hopefully we will with the Shuttle series in areas like that. And then the security, it's a pretty broad competitive landscape, depending on what security solution we talk about. If you look at the application side, which is our main focus in security, we got a lot of uniqueness there. So I wouldn't really call it anything, apart from specifically we're probably going to see more of the local and the SSL intercept space, because that's what we're bringing to market now, and we think we have got good differentiation, but nothing, no big, no big eye-openers on the competitive front.

[Rohit Chopra:]

Thanks John, thanks Andy.

[Operator:]

Thank you. Our next question is from Simon Leopold with Raymond James. Your line is now open.

[Simon Leopold:]

Great. Thank you very much. I wanted to see if you could talk a little bit more about what's going on with the public and hybrid cloud. It's my impression, the press release in your prepared comments, talked more about public cloud as an opportunity than you have in the past, and I imagine part of this is the introduction of the Shuttle series. So two things I'm trying to understand. One is, public cloud, a sense of how that percent of your business or the trends there. And then in terms of kind of hybrid applications, how much of the sales are made to the public cloud versus the enterprise customer, if we could understand the mechanics of the hybrid transaction? Thank you.

[John McAdam:]

Right. It's still a very small number. We don't give an exact percent. It's still a small number from a revenue perspective. I mean, it is really is infancy in terms of opportunity. However, we understand it's very real. The reason you are hearing more about it is that we are doing good penetration with our security products APM and the WAF. Our orchestration is becoming more important. When we've seen pieces of application move from one - from a customer, say to a public cloud, then as I mentioned, we're seeing things by programmability and iRules still being just as critical. Its areas like that, but we're talking, we're still talking fairly small, really small numbers. The other thing is that both in the hybrid cloud and in the public cloud environment, remember, we are focused on the Fortune 500 customers, we're in about 80% of the Fortune 500. They are asking us to help them from an architecture in an implementation perspective. So that gives us an advantage in that area, as well.

[Simon Leopold:]

And the mechanics of the transaction, is it generally to the enterprise customer, rather than the public cloud entity?

[John McAdam:]

There is more than one road to market. Most of what I was just describing there was involving the enterprise customer. But we also have our products available on the public clouds that can be rented, purchased, again, that small numbers, it's fast-growing, but very small numbers. But that's also important to us, and it will get more important over the next few years.

[Simon Leopold:]

And the Shuttle series is an enabler for more of this, is my understanding?

[Karl Triebes:]

Yes. This is Karl. Yes, I mean, the Shuttle series is designed with future proofing in mind, to support these cloud-based applications, in the hybrid, specifically to be able to connect seamlessly between private traditional data center and cloud-based applications. And we do that obviously through all the programmability that we provide. But also we have specialized programmable hardware that allows us to effectively create these connections, and essentially optimize these connections between the private and public and the data center.

[Simon Leopold:]

Great. Thanks for the additional detail.

[Operator:]

Thank you. Our next question is from James Suva with Citi. Your line is now open.

[John McAdam:]

Hello?

[Karl Triebes:]

Hello, there, did we lose you?

[John McAdam:]

I think we lost this question

[Operator:]

Okay. Our next question is from Simona Jankowski with Goldman Sachs. Your line is now open.

[Unidentified Analyst:]

Hi. This is Balaji on behalf of Simona. I wanted to touch on the standalone security products that you recently introduced. I know its early days, but what interest are you seeing there? And then maybe even what the rationale was for introducing standalone products now, since you haven't done this in the past?

[Karl Triebes:]

Yes, so there is a few reasons for us to go off and drive towards this. And one was that we wanted to - today, essentially we have an ADC platform that provides best of breed security, especially application security, identity access management. But it doesn't necessarily lend itself well to going and targeting specific areas within the security buying centers. And what we wanted to do was create a differentiated offering that allowed us to go out and drive essentially toward these - to better position ourselves with the security buying centers in the enterprises, cloud, et cetera. And so we picked essentially functions, if you will or products that our field had been asking us for to differentiate. And we thought that there was a broad - that there would be broad adoption of. And so one of the ones we picked, that we went after first, DDoS. We have a best-of-breed solution there, we do things both at layer four, network-based, biometric style attacks, and we also do things at the application layer. It's very differentiated that we tied these together seamlessly. Another big area has been SSL intercept, and as John mentioned in his script, we have had customers that can implement certain parts of this functionality natively on our ADC platforms, but it requires a lot of programming of iRules, things like that, to actually get that to work. So what we wanted to do was package that, make it easy to deploy and use and have differentiation specifically for that, and then charge separately for that. And the same thing with the carrier-grade firewall that we had announced. So - and this is just a first start of kind of – of a line of products, we'll have other ones that we produce, as time goes on. As part of this, we have a whole laundry list of things, and we'll have specific platforms and branding and everything else that will go out as part of that. You'll see that announced later this year.

[Unidentified Analyst:]

And in terms of customer interest, are you already in discussions?

[Karl Triebes:]

Yes, definitely. Yes, I mean, its – there is a lot of momentum as we go - especially on the SSLi side. But yes, we've definitely been in discussions with customers for quite some time, and working with the field to push it along.

[Unidentified Analyst:]

Okay, great. I just had one more clarification. You cited weak telco spending in America, but the overall telco revenues, based on your 27% comment, it looks like it grew 8% year-on-year. So where were you seeing strength and what's the difference in those markets from Americas right now?

[John McAdam:]

Yes, first of all, I don't think there is much difference in the markets. Remember I said, a lot of its project driven, it tends to be that. APAC was very strong. We had a good quarter in Japan as well, and EMEA had growth, which was reasonable.

[Unidentified Analyst:]

Okay. Great, thank you.

[John McAdam:]

Okay.

[John Eldridge:]

Sam, John Eldridge. We're going to take two more calls.

[Operator:]

Okay. Thank you. Our next question is from James Faucette with Morgan Stanley. Your line is now open.

[James Faucette:]

Thanks a lot. I just had a quick follow-up on the Japan commentary, and that was, did you have any benefit in the quarter from just a strengthening of the yen or did deal sizes remain largely unchanged when everything was priced in US dollars? I guess, just that kind of clarification. And then my second question is, when we look at - sorry, when we look at the telco projects, this is a follow-up there as well, and you mentioned that they're project based. Is that lumpiness that we're seeing right now because the projects are complete or are we just in a pause ahead of acceptances? Thank you very much

[Andy Reinland:]

Yes. So in terms of Japan, we didn't hear really anything from the Japan sales team that currency played a role in their results. We think and believe that sales execution is good there, and they are continuing to drive the business very well, but no discussion with them around currency.

[John McAdam:]

Yes, and on the service provider question, no. If you look at especially Tier 1s, as I mentioned, we - when Gi firewall project, we're just touching the initial stages of that opportunity. If you look at traffic seeding, traffic is increasing 50% a year still. So no, then there is no concept of the completeness, it's more about when you move onto stage B or stage C or do you have a completely new project like VoLTE, that type of thing.

[James Faucette:]

Okay, that's helpful. Thanks.

[John McAdam:]

Thanks.

[Operator:]

Thank you. And our last question is from Jayson Noland with Robert Baird. Your line is now open.

[Jayson Noland:]

Okay, great. I wanted to touch on the software topic. John, I think you said 38% of product revenue was software on the quarter, that's up from about a third quarter-on-quarter, which is a big move, and I assume it's a lot year-on-year, too. The press release says it's a 4X performance improvement in Virtual Editions to be released in the December quarter. So how do you get a 4X performance improvement, and what's the percent mix look near to medium-term with software?

[Karl Triebes:]

Hi. I'll take that. This is Karl, I'll take that question. On the 4X, it's a lot of really good engineering. No, we've done a lot of work on the guts of our system to - and our software, to really enable ourselves to run at these higher performance rates. And so we've been working on this for quite some time. Like I said earlier in the call, we demoed with Intel, on some of their newer CPUs, essentially an early version of our 100-gig VE that will be coming out. So when we talk about 100-gig, obviously, in terms of throughput and performance, we put some bounds essentially on what functions are actually running on that. We are not going to run a database at 100-gig on the thing, but we are running traffic, and a lot of our major functionality at that performance level.

[Jayson Noland:]

And the percent mix near medium-term, does that 38% continue to head north?

[John McAdam:]

We'll see, we'll see. I mean, remember, we're about to introduce the Shuttle series, and that actually could change that percentage. We'll see, that's going to be our goal. I mean, one of the things I have mentioned a number of times is that we have a large installed base. I mentioned this in a couple of the conference calls. We have a large installed base of products that are under contract and more than five years old. And for example, greater than five years old, we have 42,000 systems that are greater than five years old. To put that in perspective, when we did the last product refresh, we had 25,000 that were more than five years old. So we think that's an opportunity. And that could affect that percentage one way or the other. But the whole goal is to be successful in software, and to drive the Shuttle series as much as possible.

[Jayson Noland:]

Thanks, John

[John Eldridge:]

All right, thank you very much for joining us for today's call. And again, if you have any follow-up questions, please don't hesitate to call me. 206-272-6571. Thank you.

[Operator:]

Thank you, speakers. And this does conclude today's conference. Thank you for joining. All parties may disconnect at this time.