F5, Inc. (FFIV) Q4 2014 Earnings Report, Transcript and Summary

John Eldridge - Andy Reinland - Chief Finance Officer and Executive Vice President John McAdam - Chief Executive Officer, President and Executive Director Manuel F. Rivelo - Executive Vice President of Security and Strategic Solutions Karl D. Triebes - Chief Technical Officer and Executive Vice President of Product Development Edward Julian Eames - Executive Vice President of Business Operations Thomas David Feringa - Executive Vice President of Worldwide Sales

Ittai Kidron - Oppenheimer & Co. Inc., Research Division Pierre Ferragu - Sanford C. Bernstein & Co., LLC., Research Division Catharine Anne Trebnick - Dougherty & Company LLC, Research Division Brent A. Bracelin - Pacific Crest Securities, Inc., Research Division Vlad Rom - Crédit Suisse AG, Research Division Erik Suppiger - JMP Securities LLC, Research Division William H. Choi - Janney Montgomery Scott LLC, Research Division Tal Liani - BofA Merrill Lynch, Research Division Georgios Kyriakopoulos - SunTrust Robinson Humphrey, Inc., Research Division Jess L. Lubert - Wells Fargo Securities, LLC, Research Division

Good afternoon, and welcome to the F5 Networks Fourth Quarter 2014 Financial Results Conference Call. [Operator Instructions] Also, today's conference is being recorded. If you have objections, please disconnect at this time. I'd now like to turn the call over to John Eldridge, Director of Investor Relations. Sir, you may begin.

Thank you, Brian, and welcome, all of you, to our conference call for the fourth quarter and fiscal year 2014. John McAdam, President and CEO; and Andy Reinland, Executive VP and CFO, will be the speakers on today's call. Other members of our exec team are also on hand to answer questions following John and Andy's prepared comments. If you have any follow-up questions after the call, please direct them to me at (206) 272-6571. A copy of today's press release is available on our website. In addition, you can access an archived version of today's live webcast from the Events Calendar page of our website through January 21. From 4:30 p.m. today until 5:00 p.m. Pacific Time, October 30, you can also listen to a telephone replay at (866) 491-2915 or (203) 369-1722. 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 quarterly release and described in detail on our SEC filings. Please note that F5 has no duty to update any information presented in this call. Before we begin, I want to remind you that we are holding our 2014 Analyst Investor Meeting at the Sofitel Hotel in New York on Thursday, November 13. If you plan to attend the meeting, you can register online from the link on our IR Events Calendar entry for November 13. Now I will turn the call over to Andy Reinland.

Thank you, John. In my prepared remarks today, I will first discuss our results for the fourth quarter and the fiscal year ended September 30, then I will provide guidance for the current quarter, and finally, outline our general planning assumptions and expectations for fiscal year 2015. For the fourth quarter of fiscal 2014, we saw continued momentum with our key drivers, with solid results for both revenue and earnings. Revenue of $465.3 million was above our guided range of $453 million to $463 million, up 6% from the prior quarter and 18% from the fourth quarter a year ago. GAAP EPS was $1.26 per share, above our guided range of $1.15 to $1.18 per share. Non-GAAP EPS of $1.57 also exceeded our guidance of $1.46 to $1.49 per share. Q4 product revenue of $255.5 million, up 8% from Q3 and 20% from the fourth quarter of last year, represented 55% of revenue. Service revenue of $209.8 million increased 3% sequentially, 15% year-over-year and accounted for 45% of revenue. On a regional basis, the Americas grew 16% year-over-year and represented 59% of revenue. EMEA grew 22% year-over-year and accounted for 22% of overall revenue. APAC, which accounted for 14% of revenue, increased 25% year-over-year. And Japan, at 5% of revenue, grew 4% from a year ago. Enterprise customers represented 67% of Q4 total sales. Service providers accounted for 19% and government sales were 13%, including 7% from U.S. Federal. During the quarter, we have 3 greater than 10% distributors: Westcon, which accounted for 16.9% of total revenue; Ingram Micro, which accounted for 16.3%; and Avnet at 14%. Continuing down the income statement. GAAP gross margin in Q4 was 82.4%. Non-GAAP gross margin was 83.5%. GAAP operating expenses of $235.8 million were within our $232 million to $240 million guided range. Non-GAAP operating expenses were $212.8 million. Our GAAP operating margin in Q4 was 31.7% and non-GAAP operating margin was 37.8%. Our GAAP effective tax rate for the quarter was 37.2% and our non-GAAP effective tax rate was 34.5%, in line with our forecast. Turning to the balance sheet. In Q4, we generated $170 million in cash flow from operations, which contributed to cash and investments totaling $1.13 billion at year-end. For all of fiscal 2014, cash flow from operations totaled $549 million. DSO was 47 days. Inventory at the end of the quarter was $24.5 million. Deferred revenue increased 20% year-over-year to $636.7 million. In Q4, we repurchased approximately 1.32 million shares of our common stock at an average price of $113.21 per share for a total of $150 million. Approximately $331 million remains authorized under the current share repurchase program. During the quarter, we added 90 employees, ending the year with approximately 3,835 full-time employees. For the fiscal year, we added 480 employees, an increase of 14%. For the full year, with a strong close to our fiscal year, F5 exited 2014 with record top line and bottom line results, reflecting solid year-over-year revenue and earnings growth. Revenue for all fiscal 2014 was $1.73 billion, up 16.9% from fiscal 2013. Product revenue of $936.1 million was up 17.2% from the prior year and accounted for 54% of total revenue. Service revenue of $795.9 million grew 16.6% during the year and represented 46% of the total. GAAP net income for fiscal 2014 was $311.2 million or $4.09 per share. Non-GAAP net income was $413 million or $5.43 per share. Moving on to our guidance for Q1 and our fiscal year '15 outlook. Entering fiscal 2015, we are encouraged by the strength of our enterprise business, growing demand for our security products, the success of our Good, Better, Best bundles in driving larger deals, and broader adoption of our solutions. We continue to drive our leadership position in cloud with strong and maturing partnerships with industry leaders such as Cisco, HP, Microsoft and VMware, and accelerating growth of our Virtual Edition product set. In addition, we continue to win large deals in service providers with both our traditional traffic-steering solutions and telco-specific offerings such as Policy Enforcement Manager, CGNAT, and Traffix Diameter products. We also plan to formally roll out Versafe and Defense.Net as subscription services to our sales force during the current quarter. And we believe these new security offerings will meaningfully expand our addressable market opportunity. On the strength of these ongoing drivers and incremental solutions, we anticipate another year of solid growth and profitability in fiscal 2015. In preparing our Q1 guidance, we have factored in typical seasonality that we see with the start of a new fiscal year and common with peers in the tech industry. With this in mind, for the first quarter of fiscal 2015, we are targeting revenue in a range of $460 million to $470 million. We expect GAAP gross margins in the 82% range, including approximately $3 million of stock-based compensation expense and $2.7 million in amortization of purchased intangible assets. Non-GAAP gross margins are anticipated at or around 83.5%. We estimate GAAP operating expense of $245 million to $253 million, including approximately $28 million of stock-based compensation expense and $0.5 million in amortization of purchased intangible assets. We anticipate a GAAP effective tax rate of 38.5% for the quarter and a non-GAAP effective tax rate of 35.5%. Our Q1 GAAP earnings target is $1.10 to $1.13 per share. Our non-GAAP earnings target is $1.46 to $1.49 per share. We believe we will generate cash flow from operations in excess of $180 million, and we plan to increase our headcount by approximately 100 to 125 employees during the quarter. Looking out to the year ahead, our general planning assumptions and expectations for the year are as follows. We believe with our expanding product portfolio, growing customer awareness and adoption of Synthesis architecture, our partnerships with key players in the emerging SDN market and assuming no material impact to the industry from broader macro issues, we will drive year-over-year product revenue growth throughout fiscal 2015. We also expect to see, from the base of Q1, sequential growth in our business with a traditionally strong second half of the fiscal year. We anticipate that non-GAAP gross margins will remain in the 83% to 84% range. With our expectations of revenue for fiscal '15, we anticipate continued investment in our business to drive top line growth. As such, we expect non-GAAP operating margins to trend in a similar fashion to fiscal year '14, in the mid-30s range for the first half of the year and increasing through the second half. Capital expenditures are expected to range from $6 million to $12 million per quarter for ongoing infrastructure investments. We also anticipate additional CapEx of $15 million to $20 million in the second half of the year, with expansions of our facilities in both San Jose and Tel Aviv expected to come online in the summer of 2015. We expect stock compensation to increase in Q2 $5 million to $7 million, and then remain roughly at Q2 levels through the rest of the year. And finally, assuming the R&D tax credit is not extended during fiscal 2015, we expect our effective tax rates to average approximately 38.5% on a GAAP basis and 35.5% on a non-GAAP basis for the year. As John mentioned, our Analyst Investor Meeting will be November 13. We hope you can join us as our executive team presents the company's strategy and go-to-market plans for F5. With that, I will turn the call over to John McAdam.

Thanks, Andy, and good afternoon, everyone. I am sure that you all have seen the announcement regarding my decision to retire at the end of fiscal 2015 that was sent out today. I just wanted to say a few words about my decision, and then we will move on to the business in hand. It was a really difficult decision. I'll be 64 years old in February. And when I retire at the end of the fiscal year, I will be approaching the 65-year milestone. Just be clear, this was a personal decision that my wife and I agreed to, and frankly, was made harder by my profound affection for F5, our business and the F5 team. You will hear me repeat this in my quarterly remarks, but I feel really excited about the prospects open to F5 in the future, and my decision was in no way related to any negative business considerations. F5 has an awesome array of bench strength in the executive team and throughout the entire organization. My focus for 2015 is simple: number one, deliver world-class business results every quarter; and number two, work closely with our board to have a smooth and effective transition plan for my successor. Okay. Let's move on to talk about our business. I'll take a few minutes to discuss F5's performance in fiscal 2014, talk in more detail about our Q4 results, and then comment on our outlook and the exciting opportunities we see going into fiscal 2015. I was very pleased with our overall performance in fiscal 2014. The F5 team delivered overall revenue growth of 17%. This growth was split equally between Services and product growth, both at 17%. We also delivered world-class operating margins each quarter, including a non-GAAP operating margin of 37.8% in the final quarter of the year. We exited fiscal 2014 with a stellar balance sheet, with over $1.1 billion in cash and investments, having purchased $651 million of our common stock during the year. We increased our headcount by 480, ending the year with 3,835 employees. There were many highlights in fiscal 2014. Our security solutions are driving a significant number of sales wins, including many multimillion-dollar transactions. Approximately 36% of our total product sales last year included one or more security products, and this represents 41% growth over fiscal 2013. We added significant functionality to our web application firewall and access solutions, ASM and APM, and we expect to see continuing demand for these products as the complexity and sophistication of application attacks continue. There is clearly an urgent and growing requirement for customers to protect their applications in on-premise data centers and in private and public clouds. Fiscal 2014 was a forceful year of sales of our traditional firewall solution, ASM. ASM sales have grown significantly in the year, and we have won several large transactions where we replaced the incumbent competitive solutions. Project wins have included both data center firewall solutions and Gi firewall solutions with Tier 1 service providers. Our Gi firewalls are situated between a service provider's mobile network -- radio network and the Internet, and is ideal for protecting subscribers from complex attacks, such as large DDoS threats. We also significantly expanded our portfolio of subscription security solutions this past year. We added our Secure Web Gateway product, our Versafe anti-malware and anti-phishing subscription service via our Security Operations Centers, and we completed the acquisition of Defense.Net, earning a high-capacity, cloud-based service for protecting data centers from DDoS attacks. These cloud-based protection capabilities are complementary to our on-premise DDoS solution that I referred to earlier. This combination provides our customers with the most comprehensive, hybrid DDoS solution in the market, engineered to absorb the full threat spectrum of DDoS attacks. Although we have seen customer orders already for both the new cloud-based DDoS service and the anti- malware and phishing solutions, we have yet to formally release these solutions to our global sales force and partner channel. We plan to introduce these additional solutions next week at our international sales conference, along with training programs and sales collateral. The team also delivered a strong performance in the service provider market last year. I already mentioned the opportunity we have with our security products in the service provider market, especially with our Gi firewall solution. We also saw increased traction with our Policy Enforcement module, PEM, which provides integrated subscriber and application awareness, traffic steering, reporting and policy enforcement. Another area where we have seen good success in the year with service providers comes from our unique capability with TCP protocol optimization. We introduced 7 specific optimizations last year in the TMOS Vancouver and Alpine releases. These optimizations improve TCP performance when the network is experiencing packet loss and/or network congestion, typically caused by the explosion of mobile data traffic. This allows for significant cost savings by the mobile service provider, as well as providing a faster service to subscribers. Although the functionality is targeted to LTE and 4G applications, it also helps improve general data center performance, especially within virtualized data centers, where virtualized applications can burst traffic at rates exceeding 10 gigabits per second. We have also made significant progress with our Traffix Diameter solutions for LTE rollouts. Our competitive win rate is very high and we now have approximately 40 projects currently in production, with several other projects in process. In addition, I would like to point out that we now have Tier 1 service provider production wins in all theaters. These projects can be complex and very mission-critical, and we expect our focus in the next few months to be concentrated on project delivery and project rollout. We've made great progress with the product refresh opportunity throughout the year. The feedback from both existing customers and new prospects has been excellent, and I believe this opportunity will continue throughout fiscal 2015. Our installed base currently includes over 75,000 systems that have been installed for 3 years or more, approximately 40% of the installed base, which is clearly a good refresh opportunity. Another highlight last year was our progress and increasing traction with software sales, including software modules running on TMOS and software-only Virtual Edition solutions. Both our software attach rate and our Virtual Edition sales have increased steadily throughout the year. Customer reaction to Good, Better, Best -- the Good, Better, Best sales strategy has been fantastic, and I will give some specific deal details in Q4 GBB sales when I talk about our Q4 performance. Our software-only virtualization solutions continue to gain traction, with annual revenue growth up more than 49% from fiscal 2013. Fiscal 2014 was another great year for extending our technology leadership. I already mentioned the new cloud-based DDoS service, the new anti-malware and phishing solutions and the Secure Web Gateway product. We also introduced DDI integration with our APM access solution for VMware Horizon. We released BIG-IQ, our new orchestration and management platform, with 3 modules for cloud bursting, security and device management. And we delivered significant cloud and SDN integration with VMware, Cisco, Microsoft, Hewlett-Packard, Alcatel-Lucent and OpenStack. In addition, we introduced over 300 major new features across 2 major releases of TMOS. We achieved significant enhancements with our VE performance, with 10 gigabits per second available for most hypervisors. And we introduced the next-generation iControl on BIG-IP using REST to support software-defined data center and cloud-based architectures. We also added a first-ever 2U 2-slot chassis as an entry-level VIPRION product. I believe our competitive position and technology leadership is as strong as it's ever been. A good example of our competitive strength is demonstrated by our success in the Cisco ACE replacement opportunity, with another solid year of revenue from new customer ACE replacements and solid growth from existing replacements for additional sales in areas like security. We believe that our total replacements to date account for significantly less than 50% of the ACE installed base, and we expect the opportunity to continue throughout 2015 and beyond. Our Services business delivered strong performance consistently throughout fiscal 2014 and contributed to be a significant profit -- 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 continued to improve, and we once again experienced excellent renewal rates. We also continue to grow our consulting business, with increase -- which increases customer satisfaction and drives additional product revenues. Perhaps the most exciting achievement in 2014 is how we have positioned ourselves to take advantage of the potentially revolutionary and disruptive trends currently facing the technology industry. These include the accelerating adoption of public and private clouds and SDN architectures, the explosion of mobile data and LTE rollouts, complex global security threats and software-defined everything. I believe that the progress we have made with our Synthesis architecture, our technology partner ecosystem and SDN partnerships, our move into open cloud and subscription services, combined with our new pricing and business models, all combined, position us strongly for the future. Synthesis allows our customers and partners to build future-proof architectures that support on-premise solutions with the opportunity to scale to private or public clouds, as requirements dictate. As far as Q4 is concerned, I was very happy with the performance. From a sales perspective, we saw year-over-year growth in all our major regions, with especially strong results in EMEA and North America and good improvement in Asia Pacific and Japan. We also saw a marked increase in larger deals, especially million-dollar-plus deals during the quarter, both sequentially and year-over-year. We continued to experience strong momentum with our Good, Better, Best sales most [ph] in Q4, with customer adoption continuing to be very strong in the Best category. Our Services business delivered another strong quarter with a solid increase in deferred revenue, which now totals $637 million. Lastly, we are very proud to have been positioned as a leader in the Magic Quadrant for Application Delivery Controllers for 8 consecutive years. As far as the outlook is concerned, Andy stated our guidance range for Q1 and the expectations we have for sequential growth throughout fiscal 2015. We have a world-class sales force, who are efficient and motivated to drive business in the final quarter of the year, and Q4 was no exception. As usual, this leads to seasonality in Q1, which is normal in the technology market and in line with our peers. As I have mentioned several times, we believe the business drivers we have experienced in fiscal 2014 hold firm in fiscal 2015. In addition, some of the new business drivers that are subscription-based, such as Versafe anti-malware solutions and our cloud-based DDoS service, will pay dividends in a phased approach throughout the year and in the future. I believe we are uniquely well-positioned to take advantage of the significant market trends which are occurring today, and we intend to continue investing throughout the year to take advantage of these exciting opportunities. I'd like to take this opportunity to thank the entire F5 team and our partners for their tremendous efforts last year, and I look forward to their continued support for fiscal 2015. And with that, we'll now hand over the call for Q&A.

[Operator Instructions] Our first question comes from Ittai Kidron, Oppenheimer. Ittai Kidron - Oppenheimer & Co. Inc., Research Division: John, congratulations on your decision. I had a couple of questions. First for you, John, with regards to the succession plan. Do you have any view on whether the next year will be from within or without the company? And second question for you, Andy, on the service provider side for 3 quarters in a row, flat to down sequentially. Clearly, you have some big opportunities and you're making some good traction there. Can you give us a little bit more color on what's not working so well? It seems like there's no growth in that business. And what's kind of holding this back?

Yes, okay. This is John. Succession planning, as I mentioned, is clearly a top priority for the board and myself, as I mentioned in the beginning of my delivery. We are absolutely -- and I want to be very, very clear on this. I'm also very, very committed to delivering world-class quarters during the year as well. But clearly, succession planning is a top priority. I mentioned that we've got tremendous bench strength in F5 right now. So you can draw your own conclusions from that. But what we're going to do with the board is we're going to be focused on this subject, we're going to do it properly, it's going to be smooth, it's going to be professional, and I feel pretty comfortable with that. That's really all that I'm going to say on that subject right now. Ittai Kidron - Oppenheimer & Co. Inc., Research Division: Very good. And now the service provider?

Yes, so we've talked a lot about in the service provider space, so we see it as being a lumpy business for us. We still feel good about the pipeline. We feel good about what we're seeing, but clearly, we're not hitting that 20% to 25% kind of target that we talk about. But I wouldn't call out anything that I think -- maybe just softer spending, but nothing specific that I could call out relative to us and our experience with service providers that I'd highlight is something to worry about.

Yes, in fact, I mean, I think the -- we're pretty excited. I am, and so is the service provider team, about the TCP optimization stuff that we've done during the year. I wouldn't underestimate that opportunity. Basically for heavy traffic, it's a great money-saver for the -- and increases the quality for the service providers. Traffix, we feel really good about. I did mention, however, that this -- the short term, and that's probably towards the end of this year. We're very focused on making sure these big, pretty significant, complex projects we're working on with Tier 1 people goes smoothly. So that's going to be our main focus, but you'll start to see that ramp again, I'm pretty sure, as we move into the calendar 2015. And then security, security is a big one. I mean, we're starting to see traction with the Gi firewall. We've still got a lot of POCs, proof of concepts, going on. We've had orders, million-dollar-plus orders on that, and that could be very big for us. So I think there's a whole bunch of things going on there. And PEM, I mentioned, the traction in that as well.

And this is Manny. The only thing I would add to that is a lot of the footprints that we're going into are new footprints, and that means that they take long proof of concepts. John highlighted all of those. They're inserting ourselves into critical components of the network beyond the traditional traffic steering. And simultaneous with that, what we're seeing for service providers, and we are doing dozens of proof of concepts right now, is a movement to network function virtualization. So we're starting to see that also. So obviously, service providers are going through a massive transformation. Our technology is critical because it continues to drive more towards subscriber and application awareness, and movement from hardware to software or a mix of hardware and software to NFV. So that's going to take a little bit of time, but we're really excited with the progress across the board, everything that John and Andy mentioned. Ittai Kidron - Oppenheimer & Co. Inc., Research Division: So Manny, does that mean you do not expect an inflection point necessarily in the service provider this year? It could take a little bit longer before all this work just starts delivering?

There's no way we would say that. I think that'll be prudent not to say that. It is lumpy. If we hit it off with the Gi firewall, that could be interesting.

Next question from Pierre Ferragu, Bernstein. Pierre Ferragu - Sanford C. Bernstein & Co., LLC., Research Division: On the security front, you mentioned that as being like a very important driver for growth today. And I'd really like to understand how you see your position in the market evolving and who you actually compete with. So I know it's kind of like a question you've had very often, and it's kind of a silly question, but I still don't understand whether your clients, when they look for a security solution, consider you guys as well as they would consider like a traditional security player, like a Palo Alto, or if you guys actually sell security as an additional feature on your platform, but you don't really face traditional firewall players in competitive bids.

Yes, this is John. I'll just take a minute, and I think Manny and Karl can give you much more detail. The key to understand us is our position in the data center and our strength there. So most of our security solutions -- and we have access solutions as well to the mobile devices. But the key to understanding our strength is, a, we're all about the application, we're really well-placed in the data center and we have massive performance advantages. So with that, maybe Karl and Manny could give you more detail.

Yes, I'll start. This is Karl. Yes, John tried. Our focus has been the application. I mean, that started when we acquired Magnifire 10 years ago to focus on web application firewalling. And with that, we integrated that as part of our BIG-IP portfolio because we needed -- we wanted the scalability, and we've significantly added to its capabilities along the line, but the focus has been on the application. Then we added things like APM for doing things like remote access, single sign-on, build the front-end applications. And the more general discussion around security is that because we sit in the data center, and because we interact at the transactional level, we're a proxy and we're able to see both sides of the transaction, both from the client and back from the server, and understand the context of the application, we can imply -- we can apply intelligence to that connection that other security devices can't do, such as like a Palo Alto, which sits at the perimeter, which is doing distinctly different types of security services, whereas, we're focused, again, back at the application tier. There's other things that we do there as well. For example, now, we acquired Versafe to provide antifraud services. Again, because we're involved with the transactions, with the fraud -- in between the client and the server, we're able to form a trusted connection with the client dynamically and then send certain conditions and then prevent and detect these different conditions as part of that. And so our focus on security has been effectively preventing attacks against applications. Now we're extending our footprint in the data center, meaning providing other types of security, and you'll see more of that. We're advancing our DDoS capabilities. We're looking at ways to provide risk assessment, other advanced analytics as part of that, and we'll extend from there.

Yes, and this is Manny. I'll just add a couple more things to that because I think it was well-covered. The other stuff that's really important to note is that we also view the new -- there's a new perimeter in most enterprises. The perimeter, which was classically the Internet boundary wall, is no longer the case because we have devices that we bring into the corporate environment. So we're doing a lot of work around identity being the new perimeter and the way users access into the network. That's a very large growing business for us. It's our APM business. And the last piece I'll point out is as an ADC, we not only provide security services, we provide availability services and acceleration services, all simultaneously. So that gives us a very strong foothold into these accounts because we're not providing 3 separate devices to secure, accelerate and make an application highly available. We simultaneously provide that based on contextualization of the user accessing the application. So that's really been our strategy and it's taking hold in the market segment.

Next question from Catharine Trebnick, Dougherty Networks. Catharine Anne Trebnick - Dougherty & Company LLC, Research Division: This, I guess, is for Manny and Karl. Could you tell me roughly how many different use cases you would see in the different operators? I think that would help with -- because you're getting a lot of traction with Traffix and PEM, but like let's take a Tier 1 operator versus a Tier 2 operator. And how many different use cases would they use of F5 today versus maybe perhaps a year ago?

Well, Catharine, it's Manny. It's hard to -- I don't have year-on-year comparisons. So it's hard to give you that, but I'll show you when we -- on 2 weeks, when we're over at the Analyst Conference, I'll show you 11 use cases that we're selling aggressively into service providers this year. I'd have to go back and tell you how many we're doing last year. But above and beyond that, what we're seeing with service providers is not only the standard use cases we sell around TCP optimization, firewall security, application security, the list goes on and on, but we're also seeing service providers use the extensibility of our product, the openness of the platform, allowing them to program the platform to solve their unique application, traffic-steering problems and/or application problems inside that environment. And that's the power of iRules, iApps, et cetera. So it's hard to put your finger on it because we quite often get going in solving some of their application challenges when other products can't, and that's because of the capability. In addition to that, we're seeing huge momentum with them, as I said, on NFV and VEs as we go across the board. So I'll share more of that with you in 2 weeks, and you could see a slide that has the actual use cases that we're going out aggressively after.

The next question, Brent Bracelin, Pacific Crest Securities.

John, I also wish you the best on your pending retirement here. It's certainly been an impressive run as you kind of built this from a $100 million business to a company that looks like it's well on its way to a $2 billion company. You certainly will be missed. Two questions for me. One, John, in light of mixed results across the networking space, I was hoping you could talk a little bit about the pipeline visibility going into the December quarter this year versus last year. Do you see anything kind of abnormal? Or the mixed results that you're seeing across some of your peers is something maybe perhaps you're not seeing? Any color there would be helpful.

Yes. No, no, I don't see anything abnormal. I mean, as I was saying, we have a pretty good sales force, and they know what Q4 is all about. They have accelerated and they're focused. They have a sales club and they drive Q4 business. So normally, and the emphasis on normally, you will always see that the pipeline goes down somewhat because they close so much business, and that's the same as it was last year. But in terms of our like-for-like, we're seeing growth opportunities across the board and these drivers we've talked about.

Okay, that's certainly helpful. And then, Andy, a quick question for you around Services. I know we have the drag of slower product growth a year ago, dragging overall Services down. But as we think about the slowdown here to 14%, 15% growth this quarter, do you think this is kind of the low watermark and we should stabilize here? Or what's the visibility into the Services maintenance business? And when do you think that could start to reaccelerate?

Yes. I mean, the expectation is clearly for it to flatten out this year. I mean, we've come through the last 3 quarters of 20% product growth sequentially. That's going to create that pull. So every expectation is we'll see that start to trend more positively this fiscal.

And then from a visibility point, if you -- frankly, it's pretty good.

Yes, with the deferred revenue that we have, well over $600 million. Over 75% of that is current. So that gives us a good anchor when we do our analysis on the coming year.

Next question comes from Vlad Rom, Crédit Suisse. Vlad Rom - Crédit Suisse AG, Research Division: Andy, just a quick question on the guidance. So if you look at it, and you assume a little bit of deceleration on the Services line, it looks like product seasonality is perhaps more towards the low end of historic performance, just in terms of the guidance. How would -- how should we be thinking about the puts and takes embedded in the guidance? So kind of the security, sounds like it's a positive, potential rollouts on the service provider side, but can you talk about the puts and takes? And then, also, a follow-on question on the Virtual Edition. If you're seeing any potential dilution in terms of revenue with the acceleration in that product?

Yes, so we actually don't normally comment prospectively between products and service in our guidance. We pretty much let it stand. I'd go back to our comments on seasonality. When you're looking at year-over-year, if you go back and look at our guidance from a year ago relative to our results and messaging, I think you'll see similar analysis. And as John said, we're not seeing much different -- distinctly different from a year ago, and I'll leave it at that. And VE?

Yes, we are not seeing a dilution at all with the VE-type solutions. They tend to be very different from an architecture nature. They tend to be very horizontal in design. And typically, we're seeing some really big ones as well. I mean, there was an extremely big one in the federal space, for example, last quarter. And that -- when I say big, I usually mean more than $1 million. And they're solutions that we probably wouldn't actually be involved in, if it was pure appliance-type sales. So we're not seeing much of that at all. Maybe over time, we will, but certainly not anytime soon.

Next question, Erik Suppiger, JMP Securities.

First off, congratulations, John, on your decision. Best of luck. First off, I'm curious on the web app firewall. Do you think that you're taking share in that market? Or can you comment a little bit on some of the competitive dynamics that you've seen in that market over the last, say, over the course of this year?

Yes. Manny?

Yes. So yes, we feel very comfortable that we're taking share in that market segment. We just actually had a -- NSS Labs, who ran a large test on our firewall relative to everybody else's firewall, and we scored incredibly well on that. We're also seeing huge traction from our customer base across the deployment of web application firewall. And I think what you'll see is in the future us also putting our web application firewall out into the cloud. As we continue to expand our cloud-based solutions, bring that out. That will give us a full portfolio of services on-prem as well as the services in the cloud. So we feel really comfortable. We have great technology, great performance and a very, very low false positive score, which is really important in the sense that we don't see a lot of noise on the network. We actually see real vulnerabilities.

We think the WAP solution is -- I mean, it's going to be great for on-premise, and it will stay that way for a long, long time with all the policies it can do to protect the apps. As a service, we think it's got great potential. Julian's organization is working aggressively on that to provide it as a service. We'll have it in this fiscal year. And I don't know if you want to say anything about that Julian?

So we're targeting April with an upside of trying get it ready for February, but April's the plan. And with the DDoS service in front of that, we'll announce that next week. And we've opened all the data centers, so we're ready to take orders on that as well.

So this is -- because I know these are scripted, but I think Julian indeed say February. Now having said that, it's going to be during the year. We're not going to -- I don't want to be too specific. But very fast.

How's the win rate on that, on the web app firewall? Has that changed much during the course of this fiscal year?

Yes, I'd say it's the same. I mean, we do check the competitive runway and it's high, but I don't know the answer to that, Erik.

I mean, it's been -- Erik, this is Manny. It's been high always, as John pointed out. We haven't seen any material difference in that. If we don't see an account, we could lose it, of course. And the other place that we've had a couple of losses over the course of the last couple of years is when a customer doesn't want to deploy it on-prem, but instead wants to deploy it in the cloud, right? And that's part of the driver also to put our solution in the cloud. So absolutely not. At this point in time, I would say it's the same as it's been historically for us.

And the only thing is that GBB, one of the main differentiators between GBB as Best versus Best -- and one of the mains, it's not the only one, is ASM, the WAP solution. So we will take a look at this. And when we talk in 2 weeks' time, we'll maybe give you some more data.

Okay. One other quick question on the server market. Does the end of support for Microsoft's Windows 2003, does that play much of a role in terms of your demand drivers? Is there much of a refresh cycle coming over the remainder of the support contracts there?

This is Karl. I don't think there's a big impact there because, largely, we're not tied to a specific operating system. And with the movement to the cloud, with the rise of Linux, with other things that are going out there with VMware and other things, I think we're more closely correlated to that than we are a specific operating system or anything around that because we haven't seen anything to date.

Next question from Bill Choi with Janney.

John, also, congratulations. It's been quite a run over the 15 years. I guess, I wanted to get your -- some sense of what you mean by, I guess, strive for world-class quarterly performance. Beginning of last year, you certainly set your #1 priority in accelerating product growth. Any way to tie this back into the product growth perspective?

Well, yes. So we -- one of the things we do every year in the company, and we'll be rolling it out actually tomorrow, but we have something called the vital queue, and we have a number of -- many are actions that we want to do, for example, SDN partnerships, and you could probably guess a number of them. And then we normally have some financial goals as well. And obviously, just because I'm going to talk about one goal doesn't mean we want to be -- don't want the other goals to increase. But the main focus for this year, again, is product growth. That's always #1 for us.

Okay. And you're starting to partner with Cisco. That was a profound change in your relationship. I want to also get a sense of how much you're benefiting from that relationship. If you could give any sense of how big your channel partnerships have gotten? What kind of ACE replacements you've already had? Any color on that would be great.

Well, yes, the ACE replacement has been extremely significant through the year, very, very strong. And we haven't got specific revenue numbers to give you, but they're very, very strong. The number of add-ons to existing ACE replacements is in the millions, quite often it's a Fortune 500 organization. So we feel very good about that. Every QBR, quarterly business review, one of the things that we ask the sales management to talk about is the relationship with our partners like Cisco and VMware, Hewlett-Packard and Microsoft, companies like that. Because our whole goal is not just about ACE, it's all about partnering with these companies. So it's a win-win, and they gain something from the relationship, and so do we. And the progress in that, with the companies I just mentioned, has been pretty significant.

Isn't that -- that's where your larger deals are coming from?

Yes, a lot of it is influenced by that type of business. Not all of it, but a lot of it.

This is Manny. Just to add to that. John mentioned some of the key networking companies there, HP, Cisco, VMware and Microsoft. We've integrated with all of those companies our Synthesis architecture, our software-defined application services, Layer 4 through 7, with their SDN technology stacks. So obviously, where VMware would be something like NSX; with Cisco, it would be more of their ACI, APIC infrastructure; HVN with Microsoft, et cetera. But we've gone beyond that in those partnerships, in those integrations in the sense that with certain partnerships, we're also integrating with their security stacks, with their cloud stacks, and we have joint go-to-market and channel motions across the board. So the ecosystem there is broad and the ecosystem there has actual go-to-market activity associated with that. So yes, we should expect continued growth in those relationships throughout the year.

Can you quantify the channel base, I guess, for the year?

No, I don't think we'll qualify that -- quantify. But we will, by the way, talk in a lot more detail. And Eldridge just reminded me here, in 2 weeks' time. That is a specific. Again, the topic is what we're doing with these partners. You will hear a lot more about it with some interesting use cases.

Okay. This is John Eldridge. We're going to take 3 more questions, and then we're going to wrap it up.

Next question from Tal Liani, Bank of America.

The service -- in the 5 of the last 6 quarters, product growth was stronger than service growth, which is always -- or sometimes, it's a sign that service growth accelerates over the next few quarters. So can you speak about the dynamics of Services versus products? And should the stronger product growth be a leading indicator for acceleration of Services or not? Just the puts and takes there.

Tal, this is Julian. There is a relationship. It can span over 3 quarters to 4 quarters depending on where the product has been sold, whether it's refresh or not. But I think you see the indicator of it in the deferred balance that's grown by 20% and 22% in the last 2 quarters.

So does it mean that when you look at next year and the following year, I mean, without the timeframe and without the numbers, but it means that you're looking for service growth to accelerate if I just interpret your comment?

We think we're on the bottom now, and we'll start to see an increase as the reflection of that additional product sales comes in as layers on top of the service sales.

Any reason for the recurring revenue growth as a percentage of sales to also increase outside of the normal services growth?

Can you say that again?

[indiscernible] you're talking about or...

So any outside of -- I'm asking if when we go to cloud and we go to different business models of service model -- or sorry, software model instead of appliance model, there is also a question about recurring revenues. And I wanted to know what is your outlook for the recurring revenue part? Outside of the maintenance fee that you're getting on appliances, what do you think will happen to recurring revenue part of your business?

Yes, so we talked about just in next week, we're going to be launching 2 subscription services with Defense.Net and Versafe. We also have Secure Web Gateway. We think we'll see -- probably later in the year, we'll see sales as we launch this out, but that's going to go into deferred revenues. So you're probably going to see over time where that becomes -- breaking that out becomes more of an important metric on deferred subscription revenue.

And similarly, if we meet our goals in WAF and ASM, you're going to see exactly the same.

Yes.

Okay. Next question from Georgios Kyriakopoulos from SunTrust.

John, on the Cisco ACE opportunity, you mentioned that less than 50% of the installed base has been replaced. Can you talk about the typical incremental opportunity beyond load balancing?

Again, we will talk about that in a couple of weeks' time in a lot more detail. But we've looked to what we believe, from a market share and historical perspective, what the kind of installed base is. And we believe it's -- you're going to get more data on this. I don't want to be too specific. You're going to see much more than $1 billion, $1.5 billion, probably near that number. We think -- I say 50%. We actually think it's a lot less than 50% that's been covered so far. So we think the opportunity is way more than 50% still out there remaining. And we'll give you more details in that when we meet with you in a couple of weeks.

Okay. Next question, Jess Lubert, Wells Fargo Securities.

A couple of questions, maybe first for Andy. With the possible exception of the December quarter, is it fair to assume you'd expect product sales to grow sequentially through the upcoming year?

Yes, and I said that in my prepared remarks. But yes, we do.

And then federal picked up in the quarter, so I was hoping you could talk about what you saw in the market, how you expect federal business to progress. And to what degree that was just a function of some fiscal year-end buying? If there is reason to believe that we should see continued growth as we go into fiscal '15 in federal?

Dave can answer -- give you some more flavor on what we've done in federal. But remember, that was Q4 of course, just ending September. So by definition, that's always been the best growth for us, of course. So we really expect our federal business to be down in this coming quarter, as it always is, just so we're clear. But Dave, do you want to talk about Q4?

I think in Q4, I mean, I think we had a very solid quarter in federal. We actually, towards the end of the quarter, we thought it had a potential to be even larger, but we saw a couple of things. First of all, our business in the civilian and in the intelligence side of federal has been very, very strong, lots of growth and investments. And certainly, our solutions not only around ADC, but around security and cloud, are doing very, very well. In Department of Defense, we're certainly seeing a pullback. Obviously, our activities in Iraq and Afghanistan are being pulled back. And so Department of Defense is definitely pulling back. But even with that, we're seeing a lot of opportunities going into this year. So we're very bullish on this year. We think intelligence will continue to be a huge driver for us. As Department of Defense and other agencies start to going to cloud and start looking at more efficient ways of delivering services, we think that's going to play very, very well with our strategy. So like the team, I've got a very good team, very, very solid outlook in fed this year.

Okay. And then last one for me, but Grantley-based servers are now in the market. Can you help us understand to what degree the availability of these platforms might drive some incremental customer requirements or refresh activity for some of your products?

Yes, I mean, the Grantleys add significant performance. As you know, we have a pretty tight relationship with Intel, so we understand pretty far in advance what's coming and what are the specifics of these processors. In fact, we leverage a lot of their technology, as you know, in our products. But in terms of adoption, I mean, yes, it will improve performance, it allows you to run more virtual servers, you can run more applications, you can concentrate more drives, more traffic into the network, and that's all good for us. And what I think it really speaks to is efficiency of the systems on the back end. Because really what's driving the traffic, it's not just server speeds, but it's actually things that are happening on -- with mobile devices and what's happening outside the perimeter of the data center, right, that's driving these trends. So it just makes it more efficient. But yes, we expect that, that helps our case in the data center, if you will.

Jess, I wanted to clarify one element to your question that you asked. I didn't hear when you asked about the sequential growth that you were asking specifically about product, and we normally don't guide product. My comments were the total revenue, we expect to see sequential growth. So I just wanted to make that clear.

You don't expect sequential product growth for the year?

I didn't say that. It's just specifically what I thought you were asking and what I was answering was based on what we normally give, which is...

We don't normally give that data, and we're still not.

All right. Thank you all very much for joining us, and I hope you -- all of you can find a way to attend our Analyst Investor Meeting on the 13th of November. I look forward to seeing you there. Thank you.

Thank you. That does conclude the call for today. You may disconnect your phone lines at this time.