F5 Inc (FFIV) — Q1 2019 Earnings Call Transcript

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 A copy of today's press release is available on our website at F5.com, where an archived version of today's call will also be available through April 24, 2019. The telephonic replay of today's discussion will be available through midnight Pacific Time tomorrow, January 24th, 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 include words such as believe, anticipate, expect, and target. These forward-looking statements involve uncertainties and risks that may cause our actual results to differ materially from those expressed or implied by these statements. Factors that may affect our results are summarized 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 about 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 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 Executive License Agreements (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 as planned, putting us on pace to achieve our Horizon 1 target of 30% to 35% software growth in our fiscal years 2019 to 2020. 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 remain a differentiator for us. 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 continued 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 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, Americas 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’s earnings 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 three distributors accounting for more than 10% of total revenue: 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 benefited 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 the mid-30% range, driven largely by gross margin strength and operational 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. In Q1, we generated $198 million in cash flow from operations, contributing to cash and investments totaling $1.55 billion at quarter-end. Days Sales Outstanding (DSO) at the end of the quarter was 54 days, driven by service maintenance renewals at the end of FY18. Capital expenditures for the quarter were $21 million, and inventory at the end of the quarter was $31.6 million. While our adoption of ASC 606 had a minimal impact on our income statement, we did experience a few changes to 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 adoption of ASC 606. Other current and long-term assets increased by $135.5 million from the previous quarter, of which approximately 80% is due to the adoption of ASC 606, as we are now capitalizing on note receivables and commission paid on service contract sales. Finally, retained earnings increased by $130.7 million in the quarter, approximately $36 million of which was driven by the adoption of ASC 606. We ended the quarter with approximately 4,580 employees, up 170 from Q4 as we execute 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 2019. 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 toward a multi-cloud environment 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 continue to remain strong, we have seen some softness within our service provider vertical as some 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 the 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'll recall that last quarter we mentioned 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 purchased intangible assets. As a reminder, 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 costs 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.

Thank you, Frank. Before we move to Q&A, I will spend just a few minutes on the trends we're seeing in the business, highlighting some customer wins from the quarter and discussing innovation at F5. On January 15th, we released our fifth annual State of Application Services report. With input from nearly 2,000 respondents across a range of industries, company sizes, and roles, the report provides insights 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 align with our vision of expanding F5’s reach and role, as well as our efforts in the last year to repurpose investments 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 was 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 are increasingly making decisions on a per-app basis. During Q1, we had a per-app public cloud deployment with a U.S.-based cryptocurrency exchange. This customer wanted to differentiate its services to the financial industry through best-in-class security solutions for blockchain 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 the per-app infrastructure. We also provided a soccer subscription consumption model to match their end-user billing cycles. We had two BIG-IP Cloud Edition wins highlighted 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 showing 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 choose 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 toolkit they had been using. Turning to service providers, we are driving continued adoption of our NFV solutions in new areas of business with our service provider customers. In Q1, we closed deals for our DNS offerings with multiple Tier 1s globally. These customers are leveraging the combination of our extreme-scale DNS infrastructure along with the ability to protect that infrastructure with our integrated security capabilities. Additionally, we continue 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? It means they will be able to migrate or upgrade their F5 instances in minutes. They 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’ve significantly shifted our investments and resources towards innovation in automation and orchestration, Cloud-Native software, and Software-as-a-Service, and we are excited that our customers will experience these 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 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 two disruptive platforms that we believe will change the paradigm of application delivery. Both are well on track for first commercial availability in the first half of calendar 2019. I must say, I’m so proud of these teams. They have moved forward relentlessly and taken these solutions from paper to reality in an incredibly short period. Both of these offerings are now in beta stage and in the hands of early customers providing feedback on initial features. At the same time, we’re moving full steam ahead with the 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’re also innovating in new ways. For more than a year now, we have 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 these innovations to complement our goal of delivering the broadest and most consistent portfolio of application services across cloud and on-premises environments. During Q1, we announced one of the first innovations to come from this program: the open beta of our Aspen Mesh solution. With the shift from monolithic to microservice architectures, an 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 runtime. Aspen Mesh provides critical enterprise features in a platform built on top of Istio, allowing organizations to enjoy the benefits of an open-source approach without sacrificing the features, support, and guarantees needed to power enterprise applications. It’s very early days for this solution, but we've already got customers who are very interested in exploring it. These innovations represent significant 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're making toward our long-term vision for F5. We are expanding our reach and our role 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.

Hi. Thank you for the questions. First one to kick it off was just talking about your guidance for 1Q or calendar 1Q coming up, and it does not include any partial government shutdown in the past, just as a clarification, I believe I heard that earlier. And then, a 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 have actually won business but there's no one in the Central Procurement Agency to process the paperwork. And so, our guidance anticipates that this does not continue through the remainder of the quarter, but some of this is actually going to be there to process, where we’ll have to find another route to process those orders. If we find that this continues throughout the quarter, we probably would expect some impact that is not anticipated in our guidance.

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.

And then, my second question has to do with the GAAP services gross margins that continue 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 expansion? Could you potentially attribute the EPS beat in the quarter to both 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 two initiatives we've put in place last year that are bearing fruit. Generally, there's a set of transmission initiatives we have in services, but specifically, we’re leveraging more tools and AI tools and automation to deflect as many cases as possible where we can, allowing us to achieve better efficiencies and better realization 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 our gross margins.

François, I just wanted to start 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 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 from the products that are coming up in terms of Cloud-Native apps as well as F5-as-a-Service coming through later this year? How are you thinking about the drivers of this acceleration in software this year?

Hi, Samik. Yes, we’re expecting an acceleration. Generally, we feel we are on track with our Horizon 1 target. So, 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 two 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 this past Q1 than we did for all of 2018. So, we are seeing a pick-up there. I also expect that in 2019, we will see meaningful contributions from our new modes of consumption, specifically, these ELAs, 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 2019, specifically the Cloud-Native app services platform and our F5-as-a-Service SaaS offering, they will start contributing in 2019, but I would expect that more meaningful contributions come in 2020 for these propositions.

Got it. I just had a quick follow-up for Frank. Frank, the pace of repurchases has moderated over the last year. Is that due to procedural factors like blackout periods, or is it more about your current approach to capital allocation?

I would like to discuss our capital allocation strategy, not just for this year but in a broader sense. We consider cash to be a very strategic asset. For the first time in a long time, we are seeing a decent return on our cash due to interest rates, which positively impacted our other income. While we ideally want to see improvements in our top line, we are pleased to see growth in other income as well. Share repurchase is one of several options for our cash, along with dividends, mergers and acquisitions, and other possibilities. We view this as strategically important for the business and anticipate being in the range of $100 million to $150 million in the upcoming quarters. That is the expectation we want you to have and it is included in the guidance we have provided.

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 five years to the last time telecom was as low. It looks like you’ve been around $76 million down from the $100-plus-million range that prevailed throughout fiscal '18. That's the $30-plus-million drop. I know you made some comments during the call, but I was hoping you could give us some more insight in terms of what is going on in that segment and your expectations going forward?

We had a weak quarter for service providers in Q1, and we anticipate this weakness to continue for a few more quarters. This decline was especially pronounced in North America compared to the rest of the world. We're currently experiencing a transition between 4G and 5G, with many 4G projects winding down and 5G projects yet to ramp up. We are optimistic about our role in 5G, as the deployment of 5G radios will align with incoming traffic. We expect to see significant capacity upgrades in the future as 5G traffic starts to reach the core network. However, this shift is not happening yet, and we find ourselves in a transitional phase. Additionally, we secured a few projects this quarter that have been postponed, but we believe they will start to move forward in the next quarter. Overall, this trend mirrors what we observed last quarter, as we also experienced similar softness in the service provider sector.

François, to clarify, I know it's difficult to forecast in situations like this. However, considering the significant decline, moving from a $100 million to $110 million quarterly run rate maintained over the past three years, do you have insight into whether this drop is mainly due to the transition from 4G to 5G? How much of this is a true understanding, and how much is just speculation?

I would hope more of it is insight. I generally think we are already in the middle of this transition. Paul, of course, there are always areas you can look out and say, look, there are areas where we could execute better in terms of go-to-market. In fact, we are in the process of hiring on the frontend of our business. One area where we are actually doing significant hiring is in the service provider space, both in North America and internationally, because we see a strong opportunity. We think that architecturally we are well-positioned. We’ve brought in a new GM, as you know, James Feger a few months back, and we’re getting a lot of clarity around some of the future developments we’re going to make. Generally, I feel good about where our service provider business is heading. But I do think the softness we’re seeing is not going to fade away in just a quarter or two. We're going to see that for a few quarters.

Yes. Thanks for taking the question, guys. 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, your service provider accounts, and kind of what it’s done to deal size, share wins? Any kind of qualitative, quantitative feedback? How long it’s been in the system for the sales organization and kind of what outcomes you’re seeing from it?

Thanks, Alex. I'll start, and then I will ask Chad Whalen to add in terms of the pick-up with the sales team. Last year, we introduced the ELAs just last year, and really in 2018 we were essentially experimenting with the sales motion. We’ve now launched it as of November to our sales team, and we’re 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, to be ELA or subscription-based. We will see that we believe both in our enterprise base 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. When they have uncertainty regarding the lifecycle of an application or the capacity they’ll need for some application, it's a great vehicle for them to manage that uncertainty, and it also allows them to consume much faster because they don't need to deal with multiple procurement cycles. For the first ELAs that we have signed, we’re actually seeing good opportunities to expand on those ELAs when we renew them sometimes in 2019.

And just to clarify, can every account exec quote out 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. We just launched an aggressive incentive campaign for all of them, which is really driving appreciable increases to the pipeline of opportunities. At the end of the day, our customers are really embracing this because it’s an easy commercial construct for them to consume our services in any kind of mode 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 the complexity as they go through their digital transformations. In terms of sales team adoption, 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 time, as François talked about, 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.

When you mentioned about your Cloud-Native solutions without having to buy F5 hardware, could 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 and the premise if this continues to increase? Is there any way for us to frame about the detriment to hardware and the uptick on software and the impact to margins and dollars?

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 bought as package software will 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 margin. We’re in the 85% range now, and we would project being in the 85% to 87% range in that horizon. As it relates to price or top-line impact, the equation is actually fairly simple for us. The hardware today, primarily what our customers consume before the introduction of our Cloud Edition was hardware and Virtual Editions. These have been largely consumed on-prem, though we have very rapid growth now happening in the cloud. The new packaged software products that we are releasing, the Cloud Edition that came out last year and the Cloud-Native Application Services platform coming out in the first half of ‘19, those are opening up new use cases and allowing us to address applications that we had not addressed in the past, characterized as the long tail of applications. The price per unit for each of those applications is going to be less than when you are buying a big unit of hardware, of course, but the volume of applications we can address is much greater. We look at it as an extension of our addressable market and think that largely these new platforms address an incremental market and an incremental opportunity for us.

I wanted to revisit the topic of capital allocation. The Company, up until this most recent quarter, has consistently been buying back at least 150 million. With the renewal, you've updated an additional billion. I’d like to understand the Board's reasoning as well as your reasoning for not instituting a dividend of perhaps a 3% to 4% yield. This could provide some flexibility of around 75 million to 100 million per quarter if implemented and would be appealing to our broader set of shareholders. Can you clarify this for us?

Yes, Simon. Look, I will bring you back to what we said at our Analyst Investor Meeting in March. We are pursuing a growth strategy and we laid out what we think the financials are of that growth strategy. We want to use our cash as a strategic asset to pursue that growth, some of which could be used potentially for acquisitions. We want to have that flexibility if we see opportunities in the market to accelerate our growth and de-risk part of our plan. We don’t want to lose that flexibility because that’s the strategy we’re pursuing.

And could you just maybe outline your acquisition philosophy in terms of what type or size of deals you would be biased towards: technology tuck-in or larger deals that might require the Company to take on debt?

Simon, here's what I would share with you about our philosophy regarding 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 application services today. We believe we have the opportunity because of our position to offer more application services and extend our role. We will look at acquisitions that allow us to accelerate the expansion of our reach or role. One thing we may consider 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’re not constrained; we’re not looking at it just in terms of small or big. We’re really focused on whether there’s a strategic fit. The most important thing for us is to remain disciplined about it, and an emphasis on continuing to focus on organic innovation as our first priority.

I have two questions. First, can you comment on the federal strength? It looks like that grew about 30% year-over-year and love to get any comments on what's happening there. And then, François, could you remind us the difference between the Cloud Edition and the upcoming Cloud-Native app services platform just so we can level set the differentiation?

I will take the first question, and Kara will take the second one. We generally had a strong fourth quarter on federal. So, we had a good quarter there. We saw specific traction in security in that space, specifically with our SSL orchestration solution. We announced in 2018 that we were coming to market with new solutions to provide encryption and decryption of SSL traffic and build the chain of services for security stack inside of large enterprise customers. We’re seeing traction across the enterprise base for this, and we’re very excited about the pipeline we have for these solutions. Our federal team was early off the blocks with the solution, and as a result, we had a pretty strong quarter there.

With regard to your question about the difference between Cloud Edition and our Cloud-Native Application Services, I'll call out a few distinctions. Our Cloud Edition is based on our industry-leading BIG-IP application delivery controller platform. Essentially, what that is, is our virtual edition, which is licensed on a per-app model to allow for isolation of services for those application services with our BIG-IQ centralized manager solution. This enables a variety of new use cases for our customers, including operating dedicated instances for each of their applications, so it's the per-app model, as well as application troubleshooting, such that application developers no longer have to go through tedious ticketing processes to address issues when applications go down. Another aspect of the Cloud Edition is that it is really targeted for customers who have already invested heavily in our BIG-IP platform and want to extend the reach of that platform to more applications in their environment. In contrast, the Cloud-Native Application Services will be a pure software-based solution; it will only be available as a software subscription; and that will be targeted more towards a developer and DevOps audience, providing very easy-to-use, intuitive insertion of application services into applications at the time of application inception, meaning it will come out with strong integration into CI and CD pipelines.

I wanted to discuss the slowdown you mentioned in the prepared remarks. I still don’t understand if the slowdown is limited to just service providers, telecom service providers, kind of slowing down purchases? Why is it there, and/or the government? What about the general enterprise? What do you see in the general enterprise? I'm trying to understand if during the quarter, if you noticed the slowdown throughout the quarter or if it deteriorated, kind of what was the seasonality within the quarter?

So, let's address the three segments you mentioned. No, we did not see a slowdown in the federal space. Frank mentioned our situation where we have one business that cannot be processed, but we hope this resolves itself over the next few weeks. So, there has been no change in the federal government space. Largely in the enterprise, if I look at it globally, I would also say that generally, there has been no change in buying behavior. We do hear from our customers that they are observing the microenvironment and being a bit cautious about their future plans. But that cautiousness hasn’t translated yet into any change in buying behavior in the general enterprise space. In the service provider space, as I shared earlier, I believe we’re witnessing a transition between 4G and 5G, with specific projects tailing off and net new projects not really picking up yet. There wasn’t a clear linearity; as we know, the service provider business can be quite lumpy. So there wasn’t a specific linearity in the quarter related to that.

Now that 5G has a lot of edge data centers, how do you participate in edge data centers? Is it aligning with your strengths, or will it be more generic solutions from other vendors?

We are participating in several ways in 5G. The first is that we’re directly inline with a lot of the core traffic for mobile service providers. As 5G is deployed, we expect to see increased traffic on this core. Thus, we anticipate capacity upgrades as those deployments happen. As the architectures evolve to a different 5G core, not every service provider will adopt a 5G core, but when they do, we believe we will have the opportunity to expand our role. We expect an expanded role in 5G compared to our previous positions.

So far, we discussed just the demand side, not the supply side, the customers and verticals. My question is more general. We spoke about the demand based on verticals. Can you provide an outlook on your product portfolio changes and your planning for 2019? What do you envision that might materially change the growth trajectory?

A couple of things for 2019 are products and solutions that we’ve brought to market in the past six months that are going to ramp up through the year. I would point to three: our Advanced Web Applications Firewall gaining significant traction; we had a very strong security quarter, as you know, and bot defense has become an essential theme for both service providers and enterprises. Our unique and unmatched capabilities regarding bot defense is driving considerable interest. This is one aspect in our Advanced WAF today, and we are bringing more features and products around bot defense throughout the year. Second is the Cloud Edition, as I’ve mentioned, which will also continue to ramp up this year. And third is the new security offering around SSL orchestration. We had this offering in the past but required significant involvement from professional services. We just released the solution to be deployed much faster and easier by our customers, and we’re seeing strong traction. I expect all these elements to contribute to 2019. I expect our NFV offering, which we also released in Q4 2018, to contribute to our numbers in the service provider sector in 2019. We will be releasing new products in the first half of 2019 that will also begin contributing but will have a more significant impact in 2020. Overall, reviewing our supply side, we have an exciting pipeline of products that are going to contribute to the top line going forward.

Can you discuss Avi Networks? Five years ago, we always heard A10 nipping at your heels. Now, the buzz on Avi has picked up in the last six months. Could you quantify the types of use cases you run up against them, and what is your strategy to outflank them?

We are dismissive of any of our competitors, however small they may be. In the case of Avi, we don’t see them that often. When we do see them, we like our win rate. We probably haven't encountered them as much because we haven't played in the long tail of applications as we are now. Both on our Cloud Edition and the Cloud-Native App Services platform that Kara described, we’re bringing to the market a per-app consumption model that is lightweight, nimble, and cloud-native, alongside our overall capabilities of service, support, and scale built over two decades of managing mission-critical applications. We don’t believe anybody will match that anytime soon. We feel very confident in our ability to compete with them when we encounter them, though it's not very frequent.

You mentioned earlier, François, your desire to reserve some capital for acquisitions. Could you discuss technology areas where you’d like to expand, especially if there are specific deficiencies you want to address? Are you more focused on tech that's core to the business?

This is a difficult question to answer, as you can imagine. If you look at our expansion of reach and role, expanding our reach focuses more on software and cloud; expanding our role revolves more around other application services that we might want to offer. Those are important filters for considering potential actions there.

If you’re at or near that minimum cash level, would that be concerning?

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

Below that you wouldn’t be comfortable?

That’s right.