Good afternoon, and welcome to the F5 Networks First Quarter and Fiscal 2019 Financial Results Conference Call. At this time, all parties will be able to listen-only until the question-and-answer portion. Also, today's conference is being recorded. If anyone has any objections please disconnect at this time. I'd now like to turn the call over to Ms. Suzanne DuLong. Ma’am, you may begin.

Hello, and welcome. I'm Suzanne DuLong, F5's Vice President of Investor Relations. François Locoh-Donou, F5's President and CEO; and Frank Pelzer, F5's Executive Vice President and CFO, will be making prepared remarks on today's call. Other members of the F5 executive team are also on hand to answer questions during the Q&A portion of the call. A copy of today's press release is available on our website at F5.com where an archived version of today's call also will be available through April 24, 2019. The telephonic replay of today's discussion will be available through midnight Pacific Time tomorrow January 24th, and can be accessed by dialing 800-688-2171 or 402-998-0565. For additional information or follow-up questions, please reach out to me directly, at s.dulong@F5.com. Our discussion today will contain forward-looking statements, which includes words such as believe, anticipate, expect and target. These forward-looking statements involve uncertainties and risks that may cause our actual results to differ materially from those expressed or implied by these statements. Factors that may affect our results are summarized in the press release announcing our financial results and described in detail in our SEC filings. Please note that F5 has no duty to update any information presented in this call. With that, I'll turn the call over to François. François Locoh-Donou: Thank you, Suzanne, and good afternoon, everyone. Thank you for joining us today. I will talk briefly to our business drivers before handing over to Frank to review the quarter's results in detail. We delivered a solid Q1, overachieving on earnings with revenue growth of 4%. Year-on-year software growth of 21% drove our third sequential quarter of product revenue growth. Focusing on software, public cloud continues to be our strongest software growth area in this quarter, we also saw increasing demand for our security solutions, particularly…

Thank you, François, and good afternoon, everyone. As François noted, we delivered solid revenue and strong EPS growth in the quarter. First quarter revenue of $544 million was up approximately 4% year-over-year, within our guided range of $542 million to $552 million. GAAP EPS was $2.16 per share. Non-GAAP EPS of $2.70 per share was well above our guidance of $2.51 to $2.54 per share. The beats for GAAP and non-GAAP EPS were driven largely by strong gross margin, hiring that was slightly behind plan and better than expected other income. Q1 product revenue of $234 million was up 3% year-over-year and accounted for approximately 43% of total revenue. Software was approximately 19% of product revenue and grew 21% year-over-year. Systems revenue made up approximately 81% of product revenue and was down less than a percent year-over-year. Services revenue of $310 million grew 5% year-over-year and represented approximately 57% of total revenue. On a regional basis, in Q1, Americas revenue was flat year-over-year and represented 54% of total revenue. EMEA revenue grew 7% year-over-year and accounted for 27% of overall revenue. This quarter, we've combined our APAC and Japan’s earnings for external reporting to reflect the way we now view the business internally. Revenue for this combined region grew 11% year-over-year and accounted for 19% of total revenue. Sales to enterprise customers represented 65% of total sales for the quarter. Service providers accounted for 14% and government sales were 21%, including 10% from U.S. federal. In Q1, we had three greater than 10% distributors, Ingram Micro which accounted for 17% of total revenue, and Westcon and Arrow, each of which accounted for 11% of total revenue. Turning to our operating results. GAAP gross margin in Q1 was 84.1%. Non-GAAP gross margin was 85.2%, slightly better than our expectations, driven by…

[Operator Instructions] And our first question is from Sami Badri of Credit Suisse. Your line is now open.

Hi. Thank you for the questions. First one to kick it off was just talking about your guidance for 1Q or calendar 1Q coming up, and it does not include any partial government shutdown in past, just as a clarification, I believe I heard that earlier. And then, a second piece of that is, if there is any customer impact so far from the U.S. partial government shutdown? That would be great color.

Sure, Sami. So, it’s Frank. I’ll take that one first. So, to answer the second part of the question first. We have seen an impact, but it's not in probably the way that you might expect. We have actually won business but there's no one in the Central Procurement Agency to actually process the paperwork. And so, our guidance anticipates that this does not go on through the remainder of the quarter, but some of this is actually going to be there to process where we’ll find another route in which to process those orders. If we find that this continues to go throughout the quarter, we probably would expect some impact that is not anticipated in our guidance. François Locoh-Donou: Just to complete that on the question. And no, we have not seen an impact outside of the federal government in our broader enterprise business to-date.

And then, my second question has to do with the GAAP services gross margins that continues to expand, and it continues to hit a record high as of this quarter. Can you walk us through what are the dynamics that are driving expansion? Could you potentially attribute the EPS beat in the quarter to both services margin expanding and on top of that the ELA that was reported in the quarter?

Yes. So, the dynamics on the services business, there are essentially two initiatives we've put in place last year that are bearing fruits. Generally, there's a set of transmission initiatives we have in services, but specifically, we’re leveraging more tools and more AI tools and automation to deflect as many cases as possible where we can, and it's allowing us to how better efficiencies, better realization of our resources. We've also embarked on having a better distribution of our resources globally to support different geographies, and both of these efforts are benefitting in our gross margins.

Thank you. The next questions is from Samik Chatterjee of J.P. Morgan. Your line is now open.

François, I just wanted to start with the Horizon 1 targets that you have, which kind of you alluded to in terms of software growth of 30% to 35% this year. So, clearly, you’re expecting acceleration in the coming quarters. Just want to understand if you expect that to be more driven by the Cloud Edition product that you're ramping up on or is there also contribution kind of that you’re thinking of from the products that are coming up in terms of Cloud-Native apps as well as F5-as-a-Service coming through later this year, how are you thinking about kind of the driver of this acceleration in software this year? François Locoh-Donou: Hi, Samik. Yes, we’re expecting an acceleration. Generally, we feel we are on track with this Horizon 1 target. So, for everybody’s benefit, we said in Horizon 1 which is 2019 and 2020, we expected software growth to be in the 30% to 35% range. And we still feel that when you look at these two years in aggregate, that’s where we’re going to be. So, there is going to be an acceleration. The contributors, Samik, in 2019, I do expect Cloud Edition to be a meaningful contributor to that growth. We have seen continued traction with Cloud Edition. We did actually more deals on Cloud Edition just in this past Q1 than we did for all of 2018. So, we are seeing a pick-up there. And I also expect that in 2019, we will see meaningful contributions from our new modes of consumption, specifically, these ELAs, these Enterprise License Agreements and the subscription models which are also gaining traction with our customers. The newer products that will be released in the first half of calendar ‘19, specifically the Cloud-Native app services platform and our F5-as-a-Service, SaaS offering, they will start contributing in 2019, but I would expect that the more meaningful contribution comes in 2020 for these lower propositions.

Got it. And I just had a quick follow-up for Frank. Frank, the pace of repurchases moderate over the last -- what we’ve seen as a pace over the last year. Is that something procedural in terms of like blackout period et cetera, or is this more of a reflection of how you’re thinking about capital allocation this year?

I think would just say, capital allocation, not just this year but just broadly how we think about our capital allocation strategy. We think cash is very strategic asset. And for the first time in a long time, we’re actually getting some decent interest rate return on it that we saw a beat on our other income. That's clearly not necessarily where we want to beat. We want to beat on the top-line but we will take it on the operating -- on the other income line as well. I think, share repurchase is one of several alternatives for our cash. Dividends are also a possibility, M&A is also a possibility and several other things. And so, we view this as strategic to the business. And we also believe we’re likely going to be in the 100 million to 150 million range for the quarters to come. So, I think that should be the expectation that you set. It’s what we baked into the guidance that we’ve given.

Thank you. The next question is from Paul Silverstein of Cowen. Your line is now open.

If we could just focus on the telecom segment, François, if I’m looking at the numbers correctly, we’d have to go back over five years the last time telecom was as low. It looks like you’ve been around $76 million down from the $100-plus-million that prevailed throughout fiscal ‘18. That's the $30 plus million drop. I know you made some comments during the call but I was hoping you could give us some more insight in terms of what is going on in that segment and your expectations going forward? François Locoh-Donou: So, generally, we had a soft quarter on service providers in Q1, and we actually expect the softness to prolong for a couple of quarters. The softness was particularly marked more in North America than globally. And I would say that generally what we're seeing is we’re in a bit of a transition between 4G and 5G where we had a number of projects -- 4G related projects that are kind of tailing off, and 5G related projects that haven't yet picked-up. We feel pretty good about our position for 5G because as 5G radios get deployed, we are going to be in line of that traffic. So, we expect to see potentially significant capacity upgrades down the road as that 5G traffic starts hitting the GI core. But, that's not in place yet, and we think we are seeing a bit of a transition from one to the other, and we’re in between. We also saw a couple of projects that we won in quarter that were pushed out that we think will pick up in the next quarter. But, if you look at the broader trend, which we also saw last quarter -- by the way, we’re soft in service providers in Q1 -- sorry, in our Q4, that is kind of a similar trend we’re seeing, this is transition between 4G and 5G.

François, just to be clear, I understand it's hard to -- in situations like this, it’s hard to project or forecast. But, given the magnitude of the softness where again from the $100 million, $110 million quarterly run rate that has prevailed for the past three years, this dramatic fall off, is this -- do you have visibility that this is primarily or just a function of a 4G to 5G transition? How much of this is true insight, how much of this is speculation? François Locoh-Donou: I would hope more of it is insight. I generally think we are experiencing -- we are already in the middle of this transition. Paul, of course, there are always areas you can look out and say look, there are areas where in terms of go-to-market we can execute better. In fact, we are in the process of hiring on the frontend of our business. In one area where we are actually doing significant hiring is in the service provider space, both in North America and internationally, because we see strong opportunity. We think that architecturally we are well-positioned. We’ve brought in a new GM, as you know, James Feger a few months back, and we’re getting a lot of clarity around some of the future developments we’re going to make. So, generally, I feel good about where our service provider business is going to go. But, I do think the softness we’re seeing is not going to go away in just a quarter or two. I think we're going to see that for few quarters.

The next question is from Alex Kurtz of Key Capital Markets. Your line is now open.

Yes. Thanks for taking the question, guys. Just on the ELA outlook. Can you just kind of reset for us how long the enterprise sales organization has been talking to your top enterprise accounts about ELAs? And what’s your multiyear outlook for ELAs as far as adoption within your enterprise accounts, your service provider accounts, and kind of what it’s done maybe to deal size, share wins? Any kind of qualitative, quantitative feedback? How long it’s been in the system for the sales organization and kind of what outcomes you’re seeing from it? François Locoh-Donou: Thanks, Alex. I'll start and then I will ask Chad Whalen to add in terms of the pick-up with the sales team. Last year, we introduced the ELAs just last year; and really in 2018 we’re essentially experimenting with the sales motion. We’ve now launched it as of November to our sales team and we’re seeing significant excitement and traction with it. In terms of your question around the multiyear outlook for ELAs, I would say we expect over time in our Horizon 2 for a meaningful portion of our software business, if not the majority of the time to be ELA or subscription based. And we will see that we believe both in the enterprise base and to some extent in the service provider -- in the service provider space. So, it is a meaningful and important development for us. It gives our customers a lot more flexibility around where they deploy their licenses. And when they have uncertainty around the lifecycle of an application or the amount of capacity they’ll need for some application, it's a great vehicle for them to deal with that uncertainty, and it also allows them to consume much faster because they don’t have to deal with multiple procurement cycles. So, for the first ELAs that we have signed, we’re actually seeing a good opportunity to expand on those ELAs when we renew them sometimes in 2019.

And just to clarify, every account exec can quote out ELA or is it just in certain pods and certain verticals?

Yes. Hi, Alex. This is Chad Whalen. Yes, every account exec can and does quote out ELA. And in fact, we just launched an aggressive incentive campaign for all of them. And that's really driven appreciable increase to the pipeline of opportunities. At the end of the day, our customers are really embracing this vehicle because it’s an easy commercial construct to consume our services in any kind of mode that they want across the different application suites. Whether it's on-prem or in the cloud, it’s a great vehicle that can take away some of the complexity as they’re going through these digital transformations. In terms of the adoption from our sales team, it takes time to get the motion right in the market, understanding how to size it from a customer perspective and take friction out of that process. What we're seeing now after we’ve spent the time that François talked about in terms of pressure testing and learning last year, we are getting a lot more velocity in the motion and we are seeing that translate into the pipeline of opportunities now and in the future quarters.

The next question is from Jim Suva of Citi. Your line is now open.

When you mentioned about your Cloud-Native solutions without having to buy F5 hardware, could you walk us through such transactions and specifically some economics of it, dollar amount, gross margins or just generally how we should think about that and the premise if this continues increase? Is there any way for us to frame about the detriment to the hardware and the uptick on the software and the impact to margins and dollars? François Locoh-Donou: Let's start with margins. As you know, our gross margins in hardware are in the early 80s and our gross margins on Cloud-Native software by -- bought as package software are going to be in the early 90s. So, there is not a huge difference. We said in our guidance that in our Horizon 2, which was 2021, 2022, we potentially would see a bit of an uptick in gross margin. We’re in the 85% range now and we would be in the 85% to 87% range in that horizon. As it relates to the price or the top-line impact of it, the equitation is actually fairly simple for us. The hardware today, primarily what our customers consume today before introduction of our Cloud Edition was hardware and Virtual Editions. These have been largely consumed on-prem, though we have a very rapid growth now happening in the cloud. The new package software products that we are releasing, the Cloud Edition that came out last year and this Cloud-Native Application Services platform that's coming out in the first half of ‘19, those are opening up new use cases and allowing us to address applications that we have not addressed in the past that would characterize as the longer tail of applications. The price per unit for each of those applications is going to be less than when you are buying a big unit of hardware, of course, but the volume of applications we can address is much greater. And so, we look at it as an extension of our addressable market. And we think that largely these new platforms address an incremental market and an incremental opportunity for us.

Next question is from Simon Leopold of Raymond James. Your line is now open.

I wanted to come back to the topic of capital allocation. The Company up until this most recent quarter has been pretty steadily buying back at least 150 million. And then with the renewal, you updated [technical difficulty] additional billion. I wanted to see if we can better understanding of the Board's logic and your logic for why wouldn’t you institute a dividend of perhaps a 3% or 4% yield. That can give you some wiggle room of maybe 75 million to 100 million per quarter, if you go to a dividend and be attractive to our larger set of shareholders. Could you help us understand that? François Locoh-Donou: Yes, Simon. Look, I will bring you back Simon to what we said at our Analyst Investor Meeting in March. We are pursuing a growth strategy and we laid out what we think the financials are of that growth strategy. And part of that we said is we want to use our cash as a strategic asset to pursue that growth, some of which could be used potentially for acquisitions. And so, we want to have that flexibility if we see opportunities in the market to accelerate our growth or de-risk part of our plan to take the opportunity and use our cash, the strategic asset to do that. And we don’t want to lose that flexibility because that’s the strategy we’re pursuing.

And could you just maybe outline your acquisition philosophy in terms of what type or size of deals would you be biased towards technology tuck-in or larger deals that might require the Company actually take on debt? François Locoh-Donou: Simon, here is what I would share with you about our philosophy as it relates to acquisitions. We feel that we have a significant opportunity to extend our reach in terms of being able to reach every application anywhere. We think the world is becoming more application centric. We believe our growth is going to be linked to applications. And we want to reach every application anywhere. In addition to that, we offer a number of app services today. And we believe we have an opportunity because of our position to offer more application services and extend our role. We will look at acquisitions that allow us to accelerate the expansion of our reach or the expansion of our role. And when you look at it within the context, we may look at things that are what you would call tuck-ins or even acqui hires or small acquisition and-or there may be opportunities for things that are bigger. We’re not constrained and we’re not looking at it just in terms of is it small or big. We’re really looking at it in terms of, is there a strategic fit. The most important thing for me, as we go through and potentially explore these opportunities, is to make sure that we remain disciplined about it, disciplined in terms of course being continuing to focus on organic innovation as our first priority and discipline in making sure that if and when we make an acquisition that we have truly thought through how we create value from having the asset inside of F5 as opposed to outside. And as a result of that we have a very strong value creation plan through a transaction.

The next question is from Jason Ader of William Blair. Your line is now open.

I have two questions. First, can you comment on the federal strength? It looks like that grew about 30% year-over-year and love to get any comments on what's happening there. And then, secondly, François, could you remind us the difference between the Cloud Edition and the upcoming Cloud-Native app services platform just so we can kind of level set the differentiation there? François Locoh-Donou: I will take the first question and Kara will take the second one. We generally have a strong fourth quarter on federal. So, we have a good quarter there. We saw specific traction in security in that space, and specifically with our SSL orchestration solution. So, we announced in 2018 that we were coming to market with new solutions to provide encryption, decryption of SSL traffic and build the chain services for security stack inside of large enterprise customers. We’re seeing traction actually across the enterprise base for this, we’re very excited about the pipeline we have for these solution. And our federal team was early off the blocks with the solution. And as a result, we had a pretty strong quarter there.

And with regard to your question about the difference between Cloud Edition and our Cloud-Native Application Services, I'll call out a few of the distinctions. Our Cloud Edition is based on our industry-leading BIG-IP application delivery controller platform. And so, what that is, is effectively our virtual addition, which is license and a per app model to allow for isolation of services for those application services with our BIG-IQ centralized manager solution. And that enables a whole bunch of new used cases for our customers including things like operating dedicated instances for each of their applications, so it’s the per app model, as well as application trouble shooting such that application developers no longer have to go through tedious ticketing processes to get things examined in terms if applications go down. Another component of the Cloud Edition is that something that is really targeted for our customers that have already invested heavily in our BIG-IP platform and want to extend the reach of that platform to more applications in their environment. Now, in contrast the Cloud-Native Application Services will be a pure software-based solution; it will be only available as a software subscription; and that will be targeted to more of a developer and a DevOps audience and is intended to provide very easy-to-use, very intuitive insertion of application services into applications at the time of the application inception, which means that it will come out with very strong integration into CI and CD pipeline.

The next question is from Tal Liani of Bank of America Merrill Lynch. Your line is now open.

I wanted to discuss the slowdown you discussed in the prepared remarks. I still don’t understand if the slowdown is -- it's more limited to just service providers, telecom service providers, kind of slowing down purchases? And then, why is it there just there and/or the government and what about the general enterprise, what do you see in the general enterprise? I'm trying to understand if also during the quarter, if you noticed the slowdown throughout the quarter or it deteriorated kind of what was the seasonality within the quarter? François Locoh-Donou: So, let's take the three segments that you brought up. So, no, in the federal space, we did not see a slowdown. Frank mentioned to you the situation we have right now where we have one business that cannot be processed but we hope this resolves itself over the next few weeks. So, no change in the federal government space. Largely in the enterprise, if I look at it globally, I would also say that generally there has been no change in buying behavior. We do hear from our customers that they are watching the microenvironment and being a bit cautious about their future plans. But that potential cautiousness hasn’t translated yet into any change in buying behavior as being general enterprise space across the globe. In the service provider space, as I said, it was a -- I believe the transition we’re seeing between 4G and 5G and specifics to what we are seeing in terms of projects tailing off and net new projects haven’t really picked up yet. There wasn’t a particular linearity. As we know, the service provider business can be quite lumpy. So, there wasn’t a particular linearity in the quarter associated with that.

Now 5G has a lot of edge data centers, how do you participate in edge data centers? Is it playing to your strength or is it going to be more generic solutions from other vendors? François Locoh-Donou: So, we participate potentially in several ways in 5G but the first way is we’re in line of a lot of the core traffic for mobile service providers. And 5G, really those are going to bring more traffic on to this core. And so, we expect to see capacity upgrades, as a result of these deployments. When the architectures evolve to a different 5G core and not every service provider will go through a 5G core but when the architectures evolve to that, I think we will have an opportunity to expand our role, and we will get into that in future calls. But, generally, we see ourselves having a probably an expanded role in 5G from what we have to-date.

So, far we discussed just the demand side, not the supply side, just the customers and verticals. What about the supply side, what about your portfolio, what are the plans for 2019 in terms of product launches and things that are coming out to the market, and what do you think is going to -- could have the potential of changing the growth trajectory, more materially than other things? François Locoh-Donou: Your question Tal is specific to service providers...

No. My question is more general. We spoke about the demand based on verticals. But now, my question is about the supply, meaning your product portfolio changes your planning for 2019. Could you just give us kind of an outlook given that we’re at the beginning of the year, changes your paying for 2019, things that you think could be material more material than other things you're offering, et cetera? François Locoh-Donou: Yes. So, a couple of things, Tal. The first thing, if we’re looking at it in the context of 2019 are actually products and solutions that we’ve brought to market in the six months that are going to ramp up through the year. And I would point to three. One is, our Advanced Web Applications Firewall gaining a lot of traction. We had actually a very strong security quarter. We are specifically -- as you know bot defense has become a very important theme for both service providers and enterprises. And our performance and differentiation on bot is unique and we believe unmatched in the industry. That’s one and that’s -- we offer that on our Advanced WAF today. And we’re bringing more features and products around bot defense throughout the year. Second is Cloud Edition, I’ve talked about that. That will also continue to ramp throughout the year. And third is the new security offering around SSL orchestration. We had that offering in the past but it was an offering that required significant involvement of professional services. We just released the solution that can be deployed much faster and much easier by our customers and we’re seeing enormous traction with our solution. So I expect all of these things to contribute to 2019. I expect our NFV operating that we also released in the fourth quarter of 2018 to contribute to our numbers in the service provider space in 2019. And then we’re going to release new products that I talked about, in the first half of 2019, which will start to contribute but again will have a bigger in 2020. When you work at it in aggregate, to use your term, Tal, on the supply side, I think we have an exciting pipeline of products and offerings that are going to contribute to the top line going forward.

Thank you. The next question is from Catharine Trebnick of Dougherty. Your line is now open.

Can you talk a little bit about Avi Networks? Four or five -- five years ago, we always heard A10 nipping at your heels. And the last six months, the buzz on Avi has picked-up. And can you tell us maybe or quantify the number -- types of use cases that you run-up against then, and then what's your strategy to outflank them? François Locoh-Donou: So, specifically, so, we’re dismissive of any of our competitor, however small they may be. And so, in the case of Avi, we don’t see them that often. When we do see them we actually like our win rate. And that's -- we probably haven't seen them as much because we haven't played in the long tail of applications as much as we are going to be playing in the long tail of applications in 2019. And as I mentioned earlier, both on our Cloud Edition and the Cloud-Native App Services platform that Kara described, we’re bringing to the market a per app consumption model as well as really lightweight, nimble, Cloud-Native combined with our overall capabilities and service and support and scale, and a heritage of two decades of supporting mission-critical applications for our customers. And we don’t think anybody is going to match that anytime soon. And so, we actually feel very confident about competing with them, when we see them, because again, it's frankly not a very frequent occurrence.

The next question is from Rod Hall of Goldman Sachs. Your line is now open.

You mentioned earlier, I think, François, that you guys at least want to reserve some capital for acquisitions or maybe that's part of that capital plan. I'm just wonder could you talk a little bit about technology areas where you would like to expand the business in places where you think you may have deficiencies or are you thinking more something aimed at the core of the business? I mean, just kind of help us understand without giving us I guess too much, what sorts of areas you might be interested in. And then, I have a follow-up. François Locoh-Donou: Yes, Rod. So, this one is difficult one, as you can imagine. I would tell you, if you look at our expansion of reach and role, you will see that expanding our reach revolves more around software and cloud; and expanding our role revolves more around other application services that we might want to offer. And so, those would be, if you think about the horizon and the way we look at world and the filters we use, those are the filters that I would give you today for what we might do if in fact we find something that is of interest to us.

Can you say which of those two reach or role is more strategically important? François Locoh-Donou: Both are.

Okay. And then, just a housekeeping question. Do you have a minimum cash balance that you guys feel like you need to run the business?

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

Okay. If you’re kind of there, Frank, is that right?

I’m sorry. What do you mean there? We certainly have got more than our minimum. Yes, we’ve got 1.55 billion.

Okay, of your total cash and investment, so you can run that down to 400 or 500 comfortably; below that you wouldn’t be comfortable?

That’s right.

Thank you, Rod. So, with that, it was the last question for today’s conference. And that concludes today's conference. Thank you for your participation. You may disconnect at this time.