F5, Inc. (FFIV) Q1 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the F5 Networks' first quarter results conference call. (Operator Instructions). I'd now like to turn the call over to Mr. John Eldridge, Director of Investor Relations. Sir, you may begin.

Thank you, Angie, and welcome everyone to our conference call for the first quarter of 2013. The speakers on today's call are John McAdam, President and Chief Executive Officer and Andy Reinland, Chief Financial Officer. Other members of our exec team are also with us to answer questions following their prepared comments. If you have questions following today's call, please direct them to me at 206-272-6571. If you don’t have a copy of today's press release, you can get one from our website, F5.com. In addition, you can access an archived version of today's live webcast in the investor relations events calendar page of our website through April 24th. From 4:30 p.m. today until midnight Pacific Time, January 24th, you can also listen to a telephone replay at 800-695-3640 or 402-220-0318. During today's call, the discussion will contain forward-looking statements that include words such as believe, anticipate, expect, and target. These forward-looking statements involve risks and uncertainties 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 our quarterly release described in detail in our SEC filings. Before we begin, I want to remind you that F5 has no duty to update any information presented in this call. Now I'll turn the call over to Andy Reinland.

Thank you, John. Q1 marked a quarter of focused execution within a challenging macro-economic environment. Against the backdrop of our typical fiscal Q1 seasonality, we delivered our 15th consecutive quarter of sequential revenue growth reporting revenue and earnings results within our guided range. Before I discuss specific results for the quarter and our outlook for the second quarter, I would like to remind you that non-GAAP numbers exclude stock-based compensation expense and amortization of purchased and tangible assets. A reconciliation of GAAP to non-GAAP results is included in our press release. For the first quarter of fiscal 2013, revenue of $365.5 million was within our guided range of $363 to $370 million, an increase of 1% from the prior quarter and 13% year-over-year. GAAP EPS of $0.88 per diluted share and non-GAAP EPS of $1.14 per diluted share were within our guided ranges. Product revenue of $204.7 million grew 4% year-over-year and represented 56% of total revenue. Service revenue of $160.7 million grew 28% year-over-year and accounted for 44%. Q1 revenue from our Application Delivery Networking business was $359.9 million. And revenue from our ARX File Virtualization business was $5.5 million. Book-to-bill for the quarter was less than 1. Accounting for 58% of the total, revenue from the Americas grew 12% from the first quarter of 2012. EMEA, which represented 23% of revenue grew 22% from the first quarter of last year. APEC accounted for 14% of revenue and grew 16% year-over-year. Japan revenue declined 11% from a year ago and represented 5% of total revenue for the quarter. Representing 23% of sales during the quarter, Telco was our strongest vertical followed by financial at 20%, technology 13%, and total government was 11% including U.S. Federal, which accounted for 5% of the total. In Q1, we had three greater than…

Thanks, Andy, and good afternoon everyone. I was very pleased with the F5 team performance in Q1. We delivered year-over-year growth of 30%, continued to strengthen our balance sheet with strong cash generation under an increase in deferred revenue. And made significant progress in product development by introducing a range of new products with the goal of reaccelerating product revenue growth as well as increasing our solution portfolio in the addressable market for our products. From a geographic perspective, we experienced mixed results in our major regions. Business in the Americas region excluding U.S. Federal delivered solid sequential sales bookings growth over Q4. However, we saw significant sequential decline in sales in U.S. Federal business. The U.S. Federal sales in Q1 were below our normal seasonal trends and below our internal forecast. We believe the reason for this decline was directly linked to the uncertainty caused by the Fiscal Cliff discussions. The sales pipeline in our federal business remains very strong. And we feel very confident about our future opportunities in this market. Both EMEA and Asia-Pacific also delivered sequential sales bookings growth over Q4 with several large winds in each of these regions. In Japan, we experienced a significant year-over-year sequential growth in sales bookings. The booking forecast was reduced during the quarter as a well-publicized fiscal situation in Japan deteriorated. Japan in particular still has a large percentage of sales fulfilled by the mid to lower end of our appliance range of products. We believe Japan should benefit substantially from the product refresh I will talk about in a moment. We had some really good sales in the last quarter when we replaced existing Cisco ACE products with F5 solutions including three ACE replacement winds in Fortune 50 companies. Our percentage of new business in Q1 was up…

Thank you. (Operator instructions). Our first question comes from Brent Bracelin from Pacific Crest. Your line is open. Brent Bracelin – Pacific Crest Securities: Thank you. John, I really wanted to focus in on kind of the appliance refresh. Could you kind of frame for us the volume, where the bulk of the volumes within the appliances are coming from, 4,200 was shipping in the quarter, is that the high volume product or how should we think about the two additional appliances that you’ll be shipping this quarter, the 2,000 at the low end and the 10,000 at the high end? Does that provide you move coverage as you think about the competition in that environment? Are those important products that should give you a little more cover relative to the competitors and refreshing those appliances? Any color there would be very helpful. John McAdams – President, CEO: The 4,200 PB is the lower end of the midrange, so not quite the – so you know, it’s a [inaudible] product but it’s not quite the volume product in either actual volume of units or in revenue. It’s a very important product, I don’t want to put it down, it’s pretty important. The big volume product, certainly from a unit perspective, but also nontrivial from a revenue perspective is the entry-level product and that’s – you know, that’s been the case for many years and we think will continue. So the truth falls in the series because we’re talking about more than one model here, is very significant especially with things like 10 gig and [inaudible] like that. I can talk about, or maybe Karl could talk about if you want some more detail there. And then of course there at the high end of appliance range, we’ve set about even…

Thank you, Matt Robison from Wunderlich Securities. Matt Robison – Wunderlich Securities: Yes, Matt Robertson at Wunderlich. Can you comment if the – if you’ve got recognition yet for the policy enforcement, and maybe give us an update on DevCentral users? John McAdams – President, CEO: Yes – so, the policy enforcement is part of the solar release that, you know, Karl’s team is basically meeting the milestones and have it ready for the end of last calendar year. So, in truth, most of that solar stuff is this quarter – I mean, it’s this quarter and beyond, and we would expect to see sales of that. I mean, it’s very new, it will take a while to ramp up, take some training, as all software does. We – oh, by the way, we expect the platforms in sales to be much [inaudible] because they can run not in just solar, but also in previous releases like the 4200 could, and the VIPRION 2400. But with software, you know, we want to be a little bit cautious with because it does take some time to bleed through the market, but we would expect to see sales win. Karl Triebes – EVP, Product Development, CTO: Yes – and by the way, Matt, this is Karl. One thing that I would also mention with the [inaudible] module, the customers tend to have a longer sense of – search providers tend to have a much longer qualification cycle where they have to go through and run the different applications, and whatnot in their environments. So, the ramp rate of that will tend to be different than necessarily some of our other features like security, and other things in our platforms. Matt Robison – Wunderlich Securities: If it’s probably solar, than it comes with…

Thank you, Ehud Gelblum from Morgan Stanley, your line is open.

Hi guys, thanks, I appreciate it. A quick question on WesCon, as they are now 10% customer, were they – can you give us a sense geographically, was that mainly a US account, or were they more international, and was the growth there responsible for most of the uptick in services, or was that just coincidental? Andy Reinland – EVO, CFO: Hey, Ehud, the first part of your question – so, WesCon has long been a distributor of ours just to not hit that 10% threshold.

Right. Andy Reinland – EVP, CFO: And then six months ago you might have recalled a press release where we named them really our first true international distributor, and so the balance of that revenue has – I don’t have the specific breakdown, but it has gone over that 10% principle driven by international revenue, and I didn’t hear the second half of his question.

Well, basically it was following up on that – as they peak through the 10% mark from where they were before, and I don’t – we always knew there was significant… Andy Reinland – EVP, CFO: Yes.

But obviously they were in the 7-8% maybe range or so. Was that the difference in the quarter, or was it just coincidental that they happen to break through the 10% [inaudible]? Andy Reinland – EVO, CFO: I say it’s more coincidental.

It’s more coincidental, okay. John McAdams – President, CEO: Yes, definitely it’s coincidental, there is no link to any specific products here [inaudible] our geography.

Okay, helpful. With guidance, we booked a bill less than one, how should we be reading the product versus services split as we look at guidance for next quarter? Should we be looking for product revenue in sequential basis until again we can be sort of flat to perhaps downing – down a little bit with services making most of the difference given the book to bill, or should we be seeing products starting to move up on a sequential basis? Andy Reinland – EVP, CFO: Yes, when we give our guidance we always assume book to bill equal to one, so I think you can look at our guidance from that perspective, and the strong message I want to reiterate here though is we really expect to see as we go into the back half of this year, Q3, Q4, that is where we’re really going to look to see reacceleration of the product revenue growth.

Alright, okay, finally, on Japan, is – what’s your expectation on Japan for next quarter – you said most of the issues were in the low end, I would imagine there’s some competitive issues there. Is that now shipping and fixed to the point where you can start seeing that to start to rebound, is that an area that we can look if we don’t have much faith in the US Federal in the near term, is Japan an area that can start recovering sooner more in Q – in the next quarter, or the quarter after? John McAdams – President, CEO: Yes – I mean, we’re being cautious on that area – this is John. So, I mean, it’s clearly in the forecast, but we’re being pretty cautious with that – Dave, do you want to comment on what we saw last quarter? Dan Matte – EVP, Marketing and Business Development: Yes, I think we just saw, you know, pretty tough macro environment, not only from, you know, end user customer, but even with our partners as well, that we – that we, you know, just saw pretty much as the quarter went on towards the end of the quarter, really business stopped. So, you know, we’re looking at a little better quarter this quarter in Japan, but it’s still going to be a challenge.

I see, it wasn’t as competitive as you think, it’s completely the macro, and then…. John McAdams – President, CEO: We really – Dave really pushed in that during the quarter [inaudible] – well, you never really can be 100% certain, but the feedback we go back to team, and by the way, we are really – we’ve got a lot funds in this Japan management, and the team was – they really saw some

Thank you. Jess Lubert from Wells Fargo Security, your line is open.

Hi guys. Thanks for taking my question. A couple of questions. First I was hoping you could help us understand what drove the weakness in the Technology Vertical, the business has declined year-over-year and four of the last five quarters, so I’d be curious to understand. Are customers waiting for new product? Is there a competitive issue? And to what extent you believe this Vertical is likely to improve in future quarters? Dan Matte – EVP, Marketing and Business Development: Sure Jess, this is Dan. So, on the Tech Vertical issue, you’re right. I mean, the Tech Vertical has trended down over the past several quarters for us, and we believe it’s driven really by a couple of our larger customers that are taking alternative architectural approaches in terms of how they’re building things. So, generally what (dead air) and they’re building some basic functionality into that app. And, so we’ve been seeing that going on, and obviously we’re doing something about it. We’ve got projects going on internally that we believe will provide this type of customer with bays that will make it easier for them to integrate our functionality into the applications [inaudible] that they’ve got. John McAdam – President and CEO: And just to be very pointed [Inaudible]competitive at all. It’s more that you know they’ve definitely seeing some architectural in-house changes.

So, does that business kind of linger around this level the next couple of quarters, until you can implement some of these new solutions, then it ramps back up? Is that the right way to think about it? John McAdam – President and CEO: Yes, that’s probably the assumption we’re making at the moment.

And, you know, then they just want to touch base on the Carrier business, how you’re thinking about that going into 2013, clearly a better quarter here. Several major Q1 providers have suggested they’re going to spend more in 2013 than they did in 2012, so would love to get some of your thoughts, and what you’re hearing from some of the major service providers. If you’ve seen a change of tone, or an uptick in activity that has you more optimistic about the Carrier businesses as we work through the year? Manny Riveldo – EVP, Security and Strategic Solutions: Hey, Jess, this is Manny, just to comment on that. So, we’re actually seeing a lot of excitement based on the solutions that we’re bringing out to the market. And it’s primarily driven by a couple of factors. As we all know, there’s huge amounts of demand today around the mobile space. So we’ve been organizing and orchestrating over the course of the last year, is really a set of solutions for a mobile and fixed operators, that really begin to deliver advanced capabilities in terms of traffic management, and being able to send to the subscribers as what the application is. And then being able to make policy decisions around that. So, as we take these architectures out to these customers, they’re very interested in various different solutions. So, we think we’re going to have a very strong second half. But to the point that Karl make, a lot of this new technology we introduced in the market – or we’re introducing over the coming couple of weeks, is going to go into trial environments and it’s going to have to go through validation. And this will be our PAM Module, our [inaudible] Modules, our advance traffic shaping, and traffic steering capabilities, as well as continuing with our Traffix Solution set to our Diameter solutions [inaudible] market.

Would you expect the Telco business to grow faster than the Enterprise business in fiscal 2013? John McAdam – President and CEO: Possibly, and we’ve had this question so many times over the last couple of years. I think you’ll see quarters where it’s more lumpy than others. And if it’s lumpy on the high side, clearly you know, we’ll see it pick up a little bit. And certainly it’s a key [inaudible] we’ve got. You know, when we look at the products we’re bringing to market, especially in the software side of things with the application firewall and with RAM and with Carrier grade NAT, and Diameter, there’s more of an array of products, but there is going to be some lumpiness. So, I think over time yes, but I would like to talk about that in the next two or three quarters. Andy Reinland –EVP and CFO: Yes, one additional comment Jess. We’re going to be at Barcelona obviously a mobile well congress, and really rolling out these solution sets broadly. And around three key tenets: One is optimization of the carriers networks. The second is really around the modernization, so they can monetize additional service offerings, and the third is around security. Security is becoming a very, very important topic for all of the mobile operators out there. So, we have some interesting solutions coming out and look forward to sharing those with you.

Thanks guys.

Thank you. Mark Sue from RBC Capital Markets, your line is open.

Thank you gentlemen. I was just wondering on product transition. Can you think any customers might have caused the head of the new product launch? And just any thoughts on [inaudible] and some of your lower end products that so much more performance for the price than some of your mid-ranged products from the past? John McAdam – President and CEO: Yes on the potential [inaudible] it’s so hard to really, you know put numbers around that. You may remember Mark at the [inaudible] Day we did point out where we saw one or two [inaudible] was used as an example. We haven’t seen a lot of that anecdotally to be fair. But it’s a really difficult thing to judge, you know, because the customer may not tell you that they are waiting. Because we have been fairly public over these. So, we will see. I mean, we think we’re going to see a very good reaction given what happened with the 42 hundred, and given the fact that, you know they can run on solar or in the previous [inaudible] so they can move quite quickly. But I wouldn’t like to make a big statement about it, because it wasn’t obvious to – what was the other? Andy Reinland –EVP and CFO: In terms of the performance, you’re asking about performance and the impact of low end to the mid-range. I mean, one thing that we think about with these platforms is that we increased performance also to increase the ability of the platforms to run the modules. And so, we wanted to do that while byproduct of that issue increased throughput and transactional throughput as well. So that’s part of the equation that we look at as part of this. Mark Sue – RBC Capital Markets: Got it.…

Thank you. Jason Noland from Robert W. Baird, your line is open.

Great, thank you. Just to step back John, a question on your comment about challenging macros. Is that a reference to Federal and Japan, or were you seeing smaller deal sizes or delayed deals in US Enterprise in Europe. John McAdam – President and CEO: It was more of a reaction to Federal and Japan because we did see improvement in the other regions, especially in North America actually. However, we could say – in previous calls we talked about the million dollar plus deals being less than we’ve previously seen. We still saw that trend last quarter, so in in fact to be more specific, we actually saw 500 to a million dollar deals up quite significantly. But the million dollar plus ones [inaudible] to similar levels to Q4 and Q3, so we’re not dismissing that macro, because we definitely believe that is a macro scenario. Where instead of spending 1.5 million, you spend 900,000, and it really was quite significant.

So some of the upside was pushed out into this year possibly? John McAdam – President and CEO: Well possibly, and that’s an interesting question, because we are seeing the pipeline and this is obviously linked to the forecast, but we are seeing the pipeline of million dollar deals increasing. So, that’s a good sign, and we’ll see what happens, but you know, at the end of the day we’ll measure it next quarter.

Okay, last question from me on the Cisco/ACE replacement opportunity. What’s the sense of urgency out there? Are people in a hurry here, or are they just kind of sitting back waiting to see what Cisco is going to do? John McAdam – President and CEO: I think it’s pretty reasonable. I mean, I can’t remember the last time we’ve won three Fortune 50 brand new projects in a while. I also think there’s no doubt it is linked to our new business being up more than it normally is. It’s 46%, it’s usually right about the 40%. And then we did the North America, - Americas I should say, QVR at the beginning of this week and there was a lot of discussion from all the management team of the ACE opportunities. I know we’re hearing the same, and from the customers prospective, -yes I mean I guess it depends on what the application is they’re running. But if it’s mission critical, I think if I was them, I would have some options.

Thanks, John.

Thank you. Alex Kurtz, Sterne Agee, your line is open. Alex Kurtz – Sterne Agee: Yeah, thanks for taking the questions, guys. Andy, could you take us through gross margin in a little more detail this quarter. It looked like obviously very strong product margins but if I look at your guidance, it implies it being down sequentially. Can you just take us through that a little bit? Andy Reinland – EVP, CFO: Yeah. The key driver that led us to really what is now an all-time high for us on product margin was a very strong quarter in software sales. So not only software modules, but sales of our virtual addition. So we see that as good. Part of the guidance – I look at the guidance as more flattish. We do think we’ll see some pullback on the service side a little bit as we continue to hire there. Obviously, customer satisfaction is most important to us and we want to keep hiring in that area. So I see it as flattish is how I’d characterize it. Alex Kurtz – Sterne Agee: Okay, and John, just on the U.S. Federal post or close of the quarter, have any of those deals or some of the pipeline that was getting stuck at the end of the quarter, have you seen any improvement or is it the challenges continuing here? John McAdam – President, CEO: Normally we wouldn’t comment on that. We get asked that type of thing a lot. I mean, it’s not something that – yeah, there’s no big trend there that you should think about. We’re still being conservative on the Federal because it really was doing – especially sales bookings were doing quite substantially last quarter from the budget flush that happened in September. Alex Kurtz – Sterne Agee: Okay. Thanks, guys.

Rod Hall from JP Morgan, your line is open. Rod Hall – JP Morgan: Yeah, hi, guys. Thanks for taking my questions. So I just want to paraphrase what you said so far and then I had one more questions and I just wanted to make sure that this is accurate. So it sounds like you experienced Federal weakness in the quarter just [inaudible], the quarter you’re guiding, the slight revenue you’re guiding for, is that continuing Federal, underline Federal caution or are you adding to that from the Enterprise weakness? So I guess there’s a little bit of a question burred in that. And then as you look to this recovery late in the year, can you talk to us about what the main driver there is? It sounds like you think maybe the Telecom business is the primary driver for that road of recovery. And if you could quantify where you get to on growth rate as well, you know, do you get back to like a mid-teens type of growth rate by the end of the year? You know, any help you can give us there would be good. John McAdam – President, CEO: My apologizes for starting off negative, but on the final bit, we’re not going to give the growth to you ever. We’re going to take that a quarter at a time. We do think, as Andy said, we believe that in the second half total revenue growth will excel but that’s the best that we’re saying there, Rod. On the forecast, yeah, we’re being cautious in Japan and Federal. I think we have to be there. In terms of the Teleco as being the most exciting – it’s certainly up there. It’s very, very exciting, Manny talked about that, the wide range of…

Thank you. Simon Leopold from Raymond James, your line is open. Simon Leopold – Raymond James: Great. Thank you very much. I wanted to follow up on a couple things that were touched on earlier. One is in terms of – I’d like to get a better understanding of the Telco vertical use cases. Let me share my understanding of how they’ve been used is largely in the Telco data center, historically, and not really in the network and I think you’ve talked a lot in the past about opportunities and applications in the network. Could we get really a better understanding of the timeline of your expectations of let’s say greater network participation in the Telco vertical? Manny Rivelo – EVP, Security and Strategic Solutions: Yeah, so obviously, this is Manny, Simon. So obviously, the data center space is something that you mentioned you’re familiar with so I won’t go into that, but obviously there’s a litany of solutions inside the data center space that we provide. In the core network where our primary use case is, is really in [inaudible] core, sitting inside the [inaudible] core, analysing the traffic flow and being able to understand the application, the subscriber traffic flow. And based on that, be able to apply a set of network services to monetize if you will or to optimize that. So let me give you an example of that. A typical example of that would be to understand who the subscriber is, what application they’re trying to access. If that application tends to be a video application, we may re-steer that traffic to a cacheting engine as an example. Or if it’s a non-premium customer, we may rate limit that traffics so that they don’t consume all the RAM bandwidth. At the same time, depending…

Thank you. Kent Schofield from Goldman Sachs, your line is open. Kent Schofield – Goldman Sachs: Great. Thank you. To follow up on a couple of questions around software, you mentioned adding some performance features to the virtual additions. Can you talk a little bit about what those are and what those mean for your software business going forward? And then as a follow on as well to an earlier one, you mentioned some alternative approaches in the tech space. How does that software play of yours fit into hopefully addressing those alternative approaches? Karl Triebes – EVP, Productc Development and CTO: Right, so hey, Kent, this is Karl. So with the VEs, we significantly enhanced performance so now we have 3-gigabyte versions pretty much straight across all the different hypervisor types where they can allow that. So that enabled customers now in the virtual environments to run it three times faster than previously. And then with regards to – you’re referring to these customers that presume to Dan’s comments earlier about some of these environments where they’ve changed the architecture, well, in those environments, what they’ve done is they’ve gone and started leveraging some newer technology around Java Script and some technology called Node. What they’re doing there was essentially with their own development teams, kind of writing their applications to inherently understand or be a part of that framework. With our newer – some of the newer functionality coming out in the big IPs, and this is just kind of a sampling of it, we have some new APIs, these rest- based APIs, both with our new big IQ management platform. Also, we have a next-generation version of iControl that’s a part of the big IP project itself that allows it to inherently adapt better to these different Java Script or these Node or these other type of web-based environments more easily than in the past. So they can automate, manage, orchestrate their applications much easier there. So – and there’s a lot more behind that in terms of our road map of what we’re putting down with that, you know, we have some new stuff that for the cloud-based orchestration and et cetera. But we think we have a significant offering coming that, again, helps us in these different environments. Kent Schofield – Goldman Sachs: Great. Thank you for the detail there.

Thank you. Our last question comes from Toa Leone from Merrill Lynch. Your line is open. Toa Leone – Merrill Lynch: Hey. Thanks, guys. Just a quick question on the risk of – the risk in launching the products. When Cisco launched or refreshed their switches, all of their switches at the same time, they [inaudible], people bought the upgraded low-end instead of buying the high end. I’ve seen the same thing with similar companies, similar launches. What’s the risk that you see or what are you doing to mitigate the risk that when you launch so many new products together, people downgrade to a lower product, but upgraded? John McAdam – President, CEO: Yeah, and remember, we’ve done this before, Toa. Obviously, I don’t want to sound complacent about the risk because you always have to look at that type of thing. However, our platform is fairly unique in its ability to add more and more services, typically through software modules and we’ve seen from the field, a [inaudible] for the ability to do more software modules at the entry level, more capabilities with DCMP, the [inaudible] multiprocessing where we can build more and more added value to the platforms and that tends to go way far and above the cannibalization effect. We feel pretty confident – when we look at the 4,200 sales we’ve had [inaudible], that’s the way it will go. There’s more – much more [inaudible] in the terms of cannibalization. Toa Leone – Merrill Lynch: Okay. Thank you.

All right, thank you very much for joining us and we look forward to talking with you all again in a couple of months from now.