F5, Inc. (FFIV) Q4 2013 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the F5 Networks Fourth Quarter and Fiscal 2013 Financial Results Conference Call. [Operator Instructions] Also, today's call 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.

Thank you, Sharon, and welcome all of you to our conference call for the fourth quarter and fiscal year 2013. John McAdam, President and CEO, and Andy Reinland, Exec VP and Chief Financial Officer will be the speakers on today's call. The other members of our executive 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 In addition, you can access an archived version of today's live webcast from the Events Calendar page of our website through January 22. From 4:30 p.m. today until 5:00 p.m. Pacific time, October 24, you can also listen to a telephone replay at (800) 568-3652 or (203) 369-3289. During today's call, our discussion 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 our SEC filings and described in detail in our quarterly releases. Please note that F5 has no duty to update any information presented in this call. Before we begin the call, I want to remind you that we are holding our 2013 Analyst Investor Meeting at the Sofitel Hotel in New York on November 14. If you plan to attend the meeting and haven't registered, you can register online from the link on our IR Events Calendar web page for November 14. We hope you can join us there. Now I'll turn the call over to Andy Reinland.

Thank you, John. We are very pleased with the momentum we saw in our business across the back half of fiscal year 2013. Q4 was a solid finish to the year, with very strong customer reception to our new platforms, record competitive win rates and increasing traction from expanding market opportunities. Entering fiscal year 2014 with the most innovative set of products and solutions to date, we feel better than ever about our strategic position in the market and the opportunities ahead. Following my discussion of results for the fourth quarter and for fiscal year 2013, I will provide guidance for the first quarter of fiscal 2014 and outline our general planning assumptions and expectations for the year. Now our results for the fourth quarter of fiscal 2013. Revenue of $395.3 million was above our guided range of $378 million to $388 million, up 7% from the prior quarter and 9% from the fourth quarter a year ago. GAAP EPS was $0.97 per share, above our guidance of $0.93 to $0.96 per share. These GAAP EPS results include a $0.04 per share impact from a higher-than-anticipated GAAP effective tax rate due to a onetime adjustment of deferred tax assets related to Acopia. Our non-GAAP EPS was $1.26 per share, above guidance of $1.17 to $1.20 per share. Q4 product revenue of $212.3 million, up 8% from Q3 and 1% from the fourth quarter of last year, represented 54% of revenue. Service revenue of $183 million increased 5% sequentially and 20% year-over-year and accounted for 46% of revenue. Book-to-bill for the quarter was greater than 1. Q4 revenue from our Application Delivery Services business was $391.9 million and revenue from our ARX file virtualization business was $3.4 million. On a regional basis, the Americas grew 15% year-over-year and represented 59% of revenue. EMEA accounted for 22% of overall revenue, growing 7% year-over-year. APAC, representing 13% of revenue, decreased 1% year-over-year. And Japan, at 5% of revenue, was down 11% from a year ago. By vertical, finance represented 22% of sales during the quarter; telco, 18%; and technology, 15%. Total government was 14% of sales, including 7% from U.S. federal. During Q4, we had 3 greater than 10% distributors, Ingram Micro, which accounted for 16.3% of total revenue; Avnet, which represented 15.8%; and Westcon at 11.6% of revenue. Continuing down the income statement. GAAP gross margin in Q4 was 83.1%. Non-GAAP gross margin was 83.9%. GAAP operating expenses of $203.2 million were within our $199 million to $206 million guided range and included a onetime $2.4 million charge related to the consolidation of certain subleases at our corporate headquarters. Non-GAAP operating expenses were $181 million. Driven by strong Q4 revenue, GAAP operating margin was 31.7% and non-GAAP operating margin was 38.1%. Our GAAP effective tax rate for the quarter, impacted by the onetime adjustment related to deferred tax assets previously discussed, was 39.5%, above our forecast of 37%. Our non-GAAP effective tax rate was 34.5%, in line with our forecast. Turning to the balance sheet. In Q4, we generated $148 million cash flow from operations, which contributed to cash and investments totaling $1.27 billion at year end. For all of fiscal 2013, cash flow from operations totaled $500 million. DSO was 46 days. Inventory at the end of the quarter was $19 million. Deferred revenue increased 19% year-over-year to $531.4 million. In Q4, we repurchased approximately 569,000 shares of our common stock at an average price of $87.79 per share for a total of $50 million. Approximately 181 million remains authorized under the current share repurchase program. During the quarter, we added 170 employees, ending the year with approximately 3,355 full-time employees. For the fiscal year, we added 325 employees, an increase of 11%. For the full year, revenue for all of fiscal 2013 was $1.48 billion, up 8% from fiscal 2012. Product revenue of $798.9 million was down 2% from the prior year and accounted for 54% of total revenue. Service revenue of $682.5 million grew 22% during the year and represented 46% of the total. GAAP net income for fiscal 2013 was $277.3 million or $3.50 per share. Non-GAAP net income was $362.9 million or $4.59 per share. Moving on to our guidance for Q1 and our fiscal year '14 outlook. As discussed during our third quarter call, we expect to see normal seasonality as we enter a new fiscal year, characteristic of most of our peers in the tech industry. We also anticipate a more significant pullback in sales from U.S. federal government, following the disruption from the October government shutdown. At the same time, we are encouraged by the recent momentum in our business and the continued ramp in sales of our new platforms, and we plan to continue investing in the business to leverage current and emerging opportunities and drive top line growth. For the first quarter of fiscal 2014, we are targeting revenue in a range of $390 million to $400 million. We expect GAAP gross margins in the 82% to 83% range, including approximately $4 million of stock-based compensation expense and $1.7 million in amortization of purchased intangible assets. We estimate GAAP operating expenses of $219 million to $226 million, including approximately $32 million of stock-based compensation expense and $0.4 million in amortization of purchased intangible assets. As discussed on our call -- our Q3 call, we decided to move our annual date for issuing RSUs to employees from August 1 to November 1 to better align these awards with our fiscal year end and annual reviews. And we expected stock-based compensation expense to drop in Q4 and to be higher in Q1. As such, stock comp expense in Q4 decreased to $22 million from $28 million in Q3. Our Q1 '14 guidance of $36 million in total stock-based compensation reflects the upcoming annual RSU grant in November and general growth of the employee base. We anticipate an effective tax rate of 38% for the quarter and a non-GAAP effective tax rate of 35%. These estimates do not assume an extension of the federal R&D tax credit beyond 2013. Our Q1 GAAP earnings target is $0.81 to $0.84 per share. Our non-GAAP earnings target is $1.17 to $1.20 per share. We expect DSO in the 50-day range. We anticipate inventories in the range of $19 million to $21 million. We believe we will generate cash flow from operations in excess of $155 million, and we plan to increase our headcount by approximately 125 to 150 employees during the quarter. Looking out to the year ahead, our general planning assumptions and expectations for the year are as follows: We believe the company-specific drivers, new products and expanding market opportunities that propelled our growth in the second half of fiscal 2013 position us to achieve year-over-year product revenue growth throughout fiscal 2014. We anticipate overall gross margins may decline 50 to 100 basis points over the course of the year, driven by increased investment in our consulting services, which carry lower margins. It is our view that in addition to increasing services revenue, these investments drive future product growth, deal sizes, customer penetration and overall customer satisfaction. In line with our revenue expectations and as a result of our commitment to continue investing in our business to drive top line growth, we expect non-GAAP operating margins to be in the mid-30s range for the first half of the year and to strengthen to the upper 30s range in the second half. Capital expenditures are expected to be $6 million to $12 million per quarter. We expect Q2 stock compensation to be consistent with Q1 and to decrease in Q3 and Q4. Total stock compensation expense for fiscal 2014 is anticipated in the range of $130 million to $135 million. And finally, assuming the R&D tax credit is not extended during fiscal 2014, we expect our effective tax rates to average approximately 38% on a GAAP basis and 35% on a non-GAAP basis throughout the year. I'd now like to note a couple of changes in information we will be providing with our reported results beginning in Q1. We believe that the level of granularity we provide on sales by vertical segment often results in a distorted perspective on the overall trends in our business. In most cases, quarterly strength or weakness in any one vertical is more of a result of volatility rather than a significant upward or downward trend and often engenders more confusion than insight into our business momentum. As such, we have made a decision to reduce the number of vertical segments we break out. Beginning in Q1, we will no longer provide separate data for the finance and technology verticals. Instead, we will combine these with more than half a dozen other verticals, currently grouped together as other, into a single segment called Enterprise. Along with the percentage of Enterprise sales bookings during the quarter, we will continue to provide separate percentages for telco and government, including a breakout for U.S. federal. Also, beginning in Q1, we will no longer report book-to-bill on a quarterly basis. We believe the value of this metric has become very limited and will be less meaningful as we expand into new pricing and licensing models, such as our subscription-based model from our recent Versafe acquisition. We also believe inconsistencies in reporting this metric across the industry creates confusion. As such, discussion of backlog and book-to-bill could be misleading in any given quarter, both in terms of providing insight into our reported results and as a predictor of future performance. As John mentioned, we will be holding our Analyst Investor Meeting at the New York Sofitel on November 14. We look forward to seeing you there. With that, I will turn the call over to John McAdam.

Thanks, Andy, and good afternoon, everyone. I will take a few minutes to discuss F5's performance in fiscal 2013, talk in more detail about our Q4 results and then comment on our outlook and exciting opportunities we see going into fiscal 2014. Fiscal 2013 was really a tale of 2 halves. We experienced continued decline in year-over-year growth in Q1, and particularly in Q2, the quarter ending in March. In the second half of the year, we experienced strong sequential growth and improving year-over-year growth with strong sales momentum in Q4. During fiscal 2013, we continued to invest in additional headcount during the year, increasing our total net headcount by 325 employees, ending the year with a total of 3,355 employees. We exited fiscal 2013 with a stellar balance sheet with almost $1.3 billion in cash and investments and no debt, having purchased 200 million of our common stock during the year. Fiscal 2013 was very productive from a product development perspective. We completed our largest appliance product refresh ever, and we developed a host of new software solutions, which have significantly expanded our addressable market. We believe these new platforms and software solutions will drive market share gains in our key markets. New platforms delivered in the year include a high-end VIPRION 8-slot chassis and a new range of appliances, the BIG-IP 2000, 4000, 5000, 7000 and 10000 Series. We also introduced the largest portfolio of software virtualization products supporting the top 5 hypervisor platforms, VMware, Microsoft, Xen, KVM and Amazon Web Services, with the best performance in the industry. This array of new physical and virtual products enhance even further when integrated in F5's innovative ScaleN multi-tenant and clustering architecture, allowing our customers to seamlessly scale operations to realize the full value of virtualization, cloud computing and on-demand IT. Perhaps the most strategic platform which we introduced in fiscal 2013 was our new centralized management platform, BIG-IQ. Our strategy is to have BIG-IQ provide centralized management orchestration and automation for all BIG-IP modules, either standalone software solutions and/or integrated solutions. BIG-IQ is designed to provide our customers with maximum flexibility in how they deploy and manage the entire suite of F5 solutions globally, either on premise or in the cloud. We also increased our security solution portfolio during the year with the addition of the Advanced Firewall Manager, AFM. And we also added significant enhancements to our application firewall and access solutions, ASM and APM. I was extremely pleased with our execution across our security business in fiscal 2013. Approximately 30% of our total product sales last year included one or more of our key security products, ASM, APM and AFM, as part of the overall customer solution. It is clear that the architecture of our ADC platform with our TMOS full-proxy functionality provides the unique characteristics and performance needed to protect applications and individual users from complex and sophisticated attacks. There's a growing awareness of our security solutions in the marketplace, and we expect our strong sales momentum in this market to continue in fiscal 2014. We have seen growth in security sales across all our major verticals, both in the enterprise and in the service provider markets. In particular, we see a large opportunity in the service provider market with our Gi firewall solution. Our Gi firewall is situated on the perimeter between our service provider's mobile network and the Internet, and is ideal for protecting subscribers and network from complex attacks such as large DDoS threats. We are starting to see wins in the service provider market with our new policy enforcement and carrier-grade network address translation modules, and we have also made tremendous progress with our Traffix Diameter solutions for LTE rollouts. Our competitive win rate for Diameter opportunities has strengthened throughout the year, and we believe we have a real technology advantage with our Diameter solution portfolio. We are involved in some large-scale implementations with Tier 1 service provider LTE rollouts and the pipeline of future business continues to grow. Our Services business delivered strong performance consistently throughout fiscal 2013 and continued to be a significant profit and revenue growth contributor, while maintaining customer satisfaction at world-class levels. The attach rate of service-to-product sales continues to improve, and we once again experienced excellent renewal rates. We also continued to grow our consulting business, which increases customer satisfaction and drives additional product revenues. We completed 2 acquisitions during fiscal 2013. In February, we acquired LineRate Systems. Their patented technology enables web application developers to integrate programmable network services directly into applications. The LineRate technology broadens our application-focused ADC solutions and advances our overall ADC technology leadership. In September, we acquired Versafe, an existing F5 technology partner. Versafe provides state-of-the-art technology for Internet, anti-fraud, anti-phishing and anti-malware solutions. Versafe's advanced real-time web and mobile protection solutions, combined with a security operation center, will provide greater breadth to F5's existing security solutions. I believe that both of these acquisitions will prove to be strategic assets in fiscal 2014 and beyond. As far as Q4 is concerned, I am very pleased with our results. We delivered 9% year-over-year growth in spite of a cautious spending environment. More importantly, we delivered both sequential and year-over-year product revenue growth. From a geographic perspective, the Americas region was once again our best performing region, with both strong sequential and year-over-year product sales growth. Sales in EMEA were also up both year-over-year and sequentially, but sales in our Asia-Pacific, Japan region were down as we experienced a tough business environment in China. We posted another record quarter in security sales with continued momentum in AFM, APM and ASM sales. As I mentioned earlier, our Traffix Diameter LTE sales win rate continues to increase, and we delivered a record number of sales wins in Q4, with Cisco ACE replacement projects. We have now recorded over 900 ACE replacement project wins in fiscal 2013, and we continue to see the pattern where we replace ACE products with F5 platforms, offering customers additional functionality, including security, access control and application acceleration. As we begin the new fiscal year, it is appropriate to remain cautious given the well-publicized uncertain macroeconomic environment. Having said that, we believe we have a number of reasons to be confident as we move into fiscal 2014. We enter the year with a number of tangible business drivers, including the product refresh opportunity, continued security sales growth, new opportunities in the service provider market with our consolidation strategy and our Traffix LTE Diameter solutions and continued momentum with ACE replacements. More importantly, I believe F5 is uniquely positioned to take advantage of the fast-moving technology and business trends, including the growth of private and public clouds, 4G, wireless rollouts, complex global security threats, network function virtualization and software defined everything. I look forward to reviewing our strategy and future plans in some detail at our Analyst Investor Day on November 14. As far as the Q1 outlook is concerned, Andy provided our projected revenue range, as well as some of our high-level expectations for 2014. As I mentioned last quarter and several times over the last few years, we expect to see some seasonality in our business during Q1. This first quarter seasonality, which is normal in the technology market and in line with our peers, is reflected in our guidance. Acceleration of product revenue growth continues to be the major financial goal for fiscal 2014. I believe the growth drivers are in place to achieve this goal, and I remain very optimistic about the future of F5 as we enter fiscal 2014. I'd like to take this opportunity to thank the entire F5 team and their partners for their tremendous efforts last year, and I look forward to continued support in fiscal 2014. I'll now hand the call over for Q&A.

[Operator Instructions] Our first question comes from Tim Long of BMO Capital.

Just a question or 2 on the guidance, if I could. It sounds like a little bit of a period of investment here, so we're going to see operating margins probably for the next few quarters a little lower than they've been. Could you just talk about how long-term you think that would be? Is there a change in kind of the investment required? And related to that, similarly, on the gross margin, is this a sign that maybe the market is getting a little bit more competitive and these industry-leading gross margins maybe have to continue to fall a little bit?

Yes, so this is Andy. Taking the second question first on the gross margin. We haven't really seen the competitive landscape change that much. Really, for us, we see next year product margin being as strong as it's been. My comments were about wanting to invest in consulting, that it's just a lower margin business but is becoming a higher priority for us as we see the impact of getting consultants into these large customers, providing value, being a constant F5 presence and pushing our messaging and looking for new opportunities. So that will pull the margin down, but we think that will more than pay for itself. Related to the op margin, so we see it as kind of a first half, second half, right. In the first half, we want to continue investing in the business through the year. Just looking at our guidance for Q1 and the first half, we think we'll see that operating margin in the mid-30s for the first half. Second half, we should see it improve up to the upper 30s.

Okay. That upper 30s is probably more indicative of your long-term goals though?

I think it's a reality with what we think is going to happen in terms of revenue growth through the year. But as we've always done, we'll watch the business and manage accordingly.

Our next question comes from Ben Reitzes of Barclays.

Two things if I can on what you just said to Tim's question with regard to revenue growth throughout the year. I was wondering if you could be a little more -- give us a little more on that with regard to how revenue progresses throughout the year? When do you get the yield on that consulting investments that you're doing? And then you said competition hasn't changed, but Citrix just confirmed some weakness in NetScaler and obviously, they had some bigger numbers in other quarters, and it does appear that something might have changed with regard to them. And I was wondering if you could clarify your statement that nothing has changed. It seems like you guys, obviously, have rebounded. So if you could comment on the revenue trajectory throughout 2014, when you get the yield on consulting and then what you're thinking there in a little more detail, and then the competition question.

Yes, this is John McAdam. I'll answer the second question regarding the competition. I mean, nothing's changed in terms of the competitors that we're up against. But if you look at what's changed from our perspective is that we're -- obviously, we've completed the product refresh and we believe that the product refresh that we've done makes us more competitive. Also, we've added a lot of functionality to our software portfolio that I talked about. And if you look at CR security products, we think we've got best-of-breed throughout the main solution portfolio, so we're in really good position. Also, our competitive win rates. I think Andy actually mentioned this, our competitive win rates were at record levels last quarter. So we've talked about it being in the high 80s and the 90s. They actually hit record levels, which would imply that we're in a good position from a competitive perspective.

And to the other elements of your question. The revenue uptick, I'm not going to get any more definitive than the comments made in my script that we think we are very well-positioned going into the year. We do anticipate Q1 seasonality and our guidance, I think, reflects that. But we do believe we're positioned to achieve year-over-year product revenue growth throughout the year. And I'm going to leave my comments at that. Also, on consulting, we actually think the uptick on revenue there is close to immediate. I mean, the real issue is getting them in, getting them trained, but we believe the demand is there for more consulting services and we're going to hire to meet that demand.

Our next question comes from Mark Sue of RBC Capital Markets.

I'm trying to reconcile the weak first half that we saw versus the strong second half. And I'm trying to see if the second half, was that, in the cadence of it was really deferred projects that got recognized in the second half, was it just a slower ramp of the new products that we're now seeing at the moment. And just to give us some color, if we look at the annual numbers, were up 9%. We're seeing a decline there. Any thoughts of the maturation of the ADC market, John, your thoughts there? And then Andy, just a split between the higher expense, sales and marketing and R&D?

Okay. Just on the first part, yes, as I said, it really was a tale of 2 halves in fiscal 2013. If you look at the first half, we really -- we were in the -- not even in the middle of the product refresh. We'd started it at the beginning of the year, and we started bringing in some products. It was pretty well-known that we were doing the product refresh. It's hard to actually judge what the Osborne effect was in that with customers delaying. But there's definitely was some of it. So I think that was an area. The other thing that we talked about is the $1 million transactions in the first half, indicating a pretty tough spending environment from our perspective. We saw improvement in that in Q4, so I think we've seen across the enterprise, in particular, definitely an uptick in spending in Q4. And then of course, we didn't have -- we don't have that Osborne effect affecting us at all. The other thing -- so that's that. Then the other thing I think has definitely helped us in the second half is adding more software functionality, more solutions and expanding the market. The best example of that is the advanced firewall manager that we actually started, I think shipping that towards the end of February. But it really started to take off in the second half and that's also been a good driver. So there's been some fairly significant changes between those 2 halves, and I think that's the biggest difference.

Okay. John, any thoughts that market just maturing, the base ADC market. Because I know you're doing well in security but just the bread-and-butter ADC market.

I think to answer that question, you really need to sort of understand our strategy in that market. Our strategy in the ADC market, and it's been that since we come out with TMOS years ago, but the strategy is basically to make sure that our solution, the ADC, application delivery controller, is really a base platform that can be built on with extra solutions. And as you build those extra solutions, you are increasing your market. So we have constantly, over the years, increased the ADC market. Is load balancing a mature market? Absolutely. Is it significant to our strategy? Not that much. I mean we've got the best load balancer, but the key for us is our security solution, our service provider solutions, the expansion areas in the market. And from that, I would say it's the opposite. I'd say it was the ADC market, we are constantly making it an ever-increasing and newer type market.

And then, Mark, you were asking about the breakdown of sales and R&D as a percent of revenue. So non-GAAP sales was 28%. R&D was 12%.

Okay. Going into the first half, that's kind of the mix that we should expect?

We don't comment on that going forward. I think you're going to see us focus on investing from a headcount perspective pretty much as we have historically in the 30% service, 30% Dev and the rest in sales.

Our next question comes from Brent Bracelin of Pacific Crest.

One clarification and one question. The clarification was on margins. You mentioned 50 to 100 basis point decline in margins, but most of that's going to be in the service side. So just clarifying, are you indicating that product gross margin would remain at the 85% level that it's been at the last 2 years?

Yes, I think that's basically what we're laying out there. And obviously, we have some elements of our business on the software side that could drive that, but we're not planning on that improvement as we model out the year.

Okay, helpful. And then my question really ties to the product increase sequentially arose, what, 8% sequentially. That's the highest we've seen in about 2 years. If I back out the telco government business, the new general enterprise category was up 10%, strong as well. So I guess my question would be, how would you characterize what drove that increase? Was it specifically tied to the 2 new appliances, the 5000 and 7000 that shipped in the quarter where there was some pent-up demand? Was it broader-based? Any additional color you could provide relative to kind of the pipeline of opportunities and kind of what drove the momentum in the quarter would be helpful.

Yes. I mean, it was pretty broad based. I mean, if you look at some of the drivers we talk about, clearly, I mentioned the ACE replacements that we did during the year, that has obviously been a good opportunity for us, and that is very, very broad based. Security has been awesome, so security has continued. But in terms of the overall data center spending, especially in the enterprise, that was pretty wide and we saw bigger deals coming in as well. We didn't -- it wasn't linked to 2 or 3 really big opportunities. It was more broad based, but we did see an uptick on the higher end, million-dollar-plus orders.

Our next question comes from Erik Suppiger of JMP Securities.

First off, I think at your last Analyst Day, you had given us a sense for the contribution from security. Can you give us any color on kind of the size or the growth that you've seen in security during fiscal '13? And then secondly, what was the contribution from new customers versus existing customers in the quarter? And have you seen any change in terms of Cisco's reception to working with you versus the partnership with Citrix?

Yes. On the first part, I mentioned in my introduction that approximately 30% of the sales we made in fiscal 2013 had one or more of the security modules involved in the sale. So clearly, that's a pretty -- and that's up pretty significantly from the previous year, I mentioned this a couple of times, security has been a strong driver. The issue we have, and we really don't have any solution to this, is that the reason we wanted it the way we have is that our customers do more than just security with our products. That's the whole point of the ADC strategy. I mean, you could -- if you made a very strong -- if you're very biased towards security, you could say most of that business was driven that way, but that's not quite the case, its driven by a range of our portfolio of solutions, but up significantly from the previous year and linked into 30%, approximately 30% of the overall sales bookings that we're making.

And then Erik, for your question on new versus existing. So in this quarter, as we look it new business was about 47% and existing business was 53%. You compare that to a year ago where new business was about 40% versus 60%. So we are definitely seeing a trend to new business, which we think is those ACE opportunities.

Yes, and just on that you mentioned about partnering with Cisco, we -- if you look globally, there has been the odd situation where that happened. But frankly, it's been tactical and where sales teams may want to work together. The interesting thing is, we certainly don't compete with them much. There's not much competitive overlap at all. But from an ACE perspective, we feel pretty comfortable about our value proposition, partnering or not.

The next question comes from Troy Jensen of Piper Jaffray.

Andy, did you say service provider vertical is 18% of sales?

Yes, 18.

Can you guys just touch on that. If you look at year-to-date, a year ago, it looks like you did -- I excuse me, I guess I was looking at the only 3 months or 9-months over 9-months. But just in general, can you talk about the service provider verticals, seems like it's down from last year, the pipeline there, deal pushouts, anything you can say in the telco business?

Yes, and you're right. I mean, obviously, we had a pretty tough one in March, where it was 17 and 18% is definitely in the -- we've typically been doing, as you point out, Troy, between 20% and 25%, sometimes a little bit more than that. We talked about this a lot. It's very project-related, the telco business, and it tends to be lumpy. So I think you're going to see movements like that happening. Having said that, and I'm going to ask Manny to comment as well, Manny runs the service provider and the security business, but he can comment in a second. But there's bright spots. I mean, we've started to see some policy enforcement wins. We had Carrier-Grade NAT wins, these in effectively new modules, that was last quarter. I mentioned about Traffix, the revenue in Traffix is still relatively light, but the project wins are increasing rapidly. So we expect, as we start to see rollouts and milestones being met, a link to revenue, you'll start to see some benefit there. And then the big opportunity, I think, I mentioned this, is security. We're actually doing, we think we got a big opportunity with the Gi firewall, and with the firewall solutions in general. Because of the performance, because of the complexity of what we can handle. And in fact, we're actually working and looking at some trials right now with some of the large service providers where that is actually affecting our roadmap, because that's what we want to do. We want to make sure that we've got -- we customize it to their needs. So we feel, going forward, we have a real opportunity with security in particular. Manny?

I'll just comment, Troy, a couple of thoughts. I think John captured it very well. What we're seeing in the service provider arena is we're seeing service providers needing to do a couple of things. One is reduce their total cost of ownership of their networks and really address the economics out of the equation. So we're working with service providers on how we take our agency platform, really the combination of services, and deploy those services in their infrastructure, either physical implementation and/or software implementation for their NFV deployments that are out there. And really, that's about service consolidation, moving from this concept of device sprawl to eloquently managing their services. In that arena, they're also looking -- moving very aggressively in addressing the monetization side of the house. And to do that, they're becoming much more application-centric in guaranteeing quality of service, if you will, or experience to the applications. Well, what becomes really interesting is then that they need to start addressing a lot of the ADC characteristics around accelerating applications, making them available, but also the security concerns of those applications. So we think we're pretty well aligned, but as John pointed out, they take a while because they are big deals. They tend to move a little slower because of the implementations. But we feel confident with our security solutions. We feel very confident with our application and Traffix steering solutions, and really confident also with our Diameter stock to take advantage of the 4G movement that's out there.

And if I could follow up on that, Manny, you guys talk a lot about large-scale traffic wins, could you frame up what large scale is? I mean, these multi-million dollar deals initially with a lot of repeat business to follow?

These are the deals that can often be more than million dollars plus and also they can be Tier 1 providers.

All right. So we are seeing those deal across the globe in every single theater and they start out relatively small, but they're all maturing to very significant opportunities for us right now. And as you know, the 4G movement is really still in its infancy in the sense that only 1/3 of the global operators in the world have moved to Diameter. But the movement over the next couple of years is to 100%. So we expect that these 400 or so mobile operators out there that are going to be implementing Diameter solutions and only growing, over that window of time, their needs.

Our next question comes from Sanjiv Wadhwani of Stifel. Sanjiv R. Wadhwani - Stifel, Nicolaus & Co., Inc., Research Division: John, a question on ACE. You gave a metric, you've done 900 replacements. Can you talk about 2014, do you still see significant opportunities and growth in that segment of the market? And then briefly if you could touch on Japan, it sort of been down year-over-year for about a year now. So can you just talk about what's going on there?

Okay. Yes. On ACE, absolutely. I mean, we reckon the installed base is probably $1 billion plus. But the key thing we keep hammering on, because it's very real, we've got great experience of this now, is that when we do an ACE replacement it's typically a new project and certainly -- or a new account for us and it means we can sell more of our solution portfolio. Security is the best example, but not the only example. So as we've seen this pattern, so we think it's the actual market opportunity is much bigger than $1 billion. So it's probably at least a 2- to 3-year market we will be talking about. But remember, once we get into accounts like these accounts, we sell much more so it's effectively an everlasting opportunity for us. And what was the -- oh, Japan was the other question. Yes, you're right. I mean, we -- what we're seeing in Japan is we definitely saw a big jump in business after the tsunami, and I think there was clearly a lot of data center builds happened. And last year, in particular, 2013, was a pretty tough comparison every single quarter, with those data center build-outs. So we would expect to see year-over-year growth now in most, if not all quarters. We'll see, we'll take this a step at a time, growth in Japan. So not too worried about it. I do think 2014 is going to look better from a comparison's perspective.

Our next question comes from Paul Silverstein of Cowen and Company.

Just a couple of quick questions, guys. First off, Andy, I trust it goes without saying in terms of your product gross margin commentary that pricing has not become a more meaningful issue?

Yes. We have not seen a change in the competitive environment other than our comments on increasing win rates. So yes, pricing has not changed.

I mean, the question has been asked 2 or 3 times. Just to be really clear on this, the gross margin that we're talking about is about consulting resources and professional services. To push projects faster, get product revenue faster and increase customer satisfaction, and we're seeing a real demand for it from the customer base, so it's not something we can ignore.

Understood. Secondly, I heard your comments about the number of million-dollar deals having picked up, versus they've been lackluster for several quarters they've picked up this quarter, I heard that. But can you comment on average deal size? Can you give us a number, either or some rough quantification versus the preceding quarter?

Yes. So it's actually been fairly constant over the last 2 quarters, right at 100,000. And interestingly enough, if you go back to Q4 a year ago, it was right at 100,000. So we've seen it be pretty consistent at that level.

Was there a dip? Refresh my memory, was there a dip in the intervening couple of quarters? When you say a year ago, was that 100 and the last 2 quarters, it was at 100?

No, it's actually been fairly consistent through the year.

One more if I may, if you already answered this, my apologies. But when you look at the government vertical, everyone's obviously talking about government concerns, goes without saying. What are you guys seeing?

Yes, it's John here. I mean, basically, first of all, main thing is that we've got great pipeline there. We had a pretty good Q4. We feel really good about our team. But I think you'd be crazy right now to make any future type statements on a federal government, in particular, I'm talking about. So we'll just see how things roll out. But I think in terms of what we do across the government, the fact that it's very Internet-based, the fact that their consolidating data centers, I think is going to remain a good vertical for us. But we're certainly not going to talk forward-looking, especially in the short-term over the next 6 months. We'll see -- we're clearly taking a conservative view when we come up with guidance.

John, Can I squeeze one more in. With respect to the December guidance, are you all expecting product revenue to -- can you give us some sense for what your expectation is? It just turned positive for the first time in a while, I mean, year-over-year perspective, should we expect...

Andy stated in his introduction, I think he actually repeated in the question that we would expect to see product revenue growth year-over-year each quarter next year.

But can you give us some quantification from [indiscernible]

That's all we're giving you.

Our next question comes from Simon Leopold of Raymond James. Simon M. Leopold - Raymond James & Associates, Inc., Research Division: A couple of things. Just a quick clarification, on the fiscal year commentary, you talked about gross margin declining 50 to 100 basis points through the year and you've also talked about the services pushed towards lower margin consulting. So I just wanted to see what's your thinking in terms of your product gross margin through the year, essentially is the 50 to 100 all because of services? Or is there some element of gross margin decline in your products?

Okay. I don't like to be aggressive here but, clearly, we've made this point a couple of times. So I'll make it again and please don't ask anybody else on the call. The consultancy is why the gross margin -- we're going to see some small decline there. It's not in product. We feel really strong about our product competitiveness. We've added more software modules, so there's always a chance that we actually can improve that. And we're not being pushed in services down to the lower-type end [ph]. We're actually, it's incremental. Our core Services business remains great with high renewal rates, high attach rates, all that good stuff. But as we get more and more complex environments, whether it's large rollouts or whatever, customers would like more and more consultancy from us and we're addressing that customer needs. Simon M. Leopold - Raymond James & Associates, Inc., Research Division: I also want to see if you could touch on China. You talked about that being weak in the quarter. Other tech companies have talked about China issues. If you could help us understand, first of all, what your exposure is to China and what your thoughts are in terms of what caused the issues?

Yes. It's definitely been a tough environment. I know -- probably like you have been listening to other vendors as well. I mean, we're just seeing a tough spending environment that basically the number of government-sponsored projects seems to be reduced. I don't know how long it's going to last. Our exposure isn't massive. I mean, we've got good operation in China, a number of offices there. But it's a smaller percentage of our business. I don't think it's a massive exposure. And frankly, moving forward, I don't think it's a big exposure at all because we probably have a low baseline there, but we did think we should call it out.

Our next question comes from Brian Modoff of Deutsche Bank.

I won't ask a question with a negative connotation. A couple of things. Can you talk a little bit about the telco side? You were saying that you're starting to see bigger opportunities there. Do you expect as a percent of revenue through the year, do you expect that to grow larger? And then, how's management viewing your NexGen network firewall opportunity, TAM point of view, looking mainly at kind of $2 billion ingress market or are you looking at the full $7 billion security TAM?

All right. They're both in Manny's field. I'll mention -- He can mention the security, I'll just talk again about telco. It's hard to predict in terms of if you took the whole year where we think it will be percentage-wise. I think you're going to see a similar trend of what we've seen. So some good quarters as projects rollout, and then maybe some not too good ones as we've seen some project delays. But we really do see some strong opportunities in telco. We think we've got great a strategy with the consolidation strategy that fits exactly where they want to go in terms of reducing the number of boxes, having them in one consolidated solution, whether it's Policy Management, Traffix D, security. Security and sales, we think could definitely be extremely good for us, especially if we execute on these trials and bring the functionality that we're working on feverishly. We think that could be a very big opportunity for us. And then as we've mentioned a couple of times, we feel our Traffix win rate is definitely improving, and improved dramatically over the last fiscal year. So we've got some real good tangible drivers there. So Manny can talk about security and obviously, comment on telco as well.

Brian, let me give you some more background on security area. So if we feel look at security, it's a little broader than that, just the NexGen firewall. And we'll break this out for you in 2 weeks or in New York at the Analyst Day. But some of the markets that we're after are the firewall market, and that is not the NexGen traditional firewall market, think about that more as the -- or the NexGen new market, think about it more as the traditional firewall market, which is a $2 billion market. But above and beyond that market, we're in a security market segment around web application firewall. We are in the market around web access management. We're in the market around remote access, DDoS protection, mobile security management and web anti-fraud. So the market is significantly larger and has a very large CAGR that's actually going to exceed that $7 billion. So we'll share that information with you, but it's much more than just firewall, it's a whole solution set, both for the user, for the network and for the applications.

Okay. Thanks a lot for joining us, and we hope many of you will be able to attend our Analyst Meeting in New York on November 14. And for those of you who can't, we look forward to talking with you next quarter.

That concludes today's conference. Thank you for your participation. You may now disconnect.