F5 Inc

NASDAQ:FFIV

Earnings Call Transcript 2018-Q3

[Operator]

Good afternoon, and welcome to the F5 Networks' Third Quarter and Fiscal 2018 Financial Results Conference Call. At this time, all parties will be able to listen only until the question-and-answer portion. Also, this conference is being recorded. If anyone has any objections, please disconnect at this time.

I'd like to turn the call over to Mr. Dennis Melton, Interim Head of Investor Relations. Sir, you may begin.

[Dennis Melton, F5 Networks, Inc.]

Thank you and good afternoon, everyone. As the operator said, I am Dennis Melton, F5's Interim Lead of Investor Relations. François Locoh-Donou, President and CEO of F5; and Frank Pelzer, Executive VP and CFO, will be the speakers on today's call. Other members of the F5 executive team are also on hand to answer questions following the prepared remarks.

If you have any questions after the call, please direct them to me at 206-272-6078 or [e-mail]. A copy of today's press release is available on our website at www.f5.com. In addition, you can access an archived version of today's call from our website through October 24, 2018. You can also listen to a telephone replay at 866-511-5155 or 203-369-1955.

In 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 on our quarterly release and described in detail in our SEC filings. Please note that F5 has no duty to update any information presented in this call.

I will now turn the call over to Frank.

[Francis J. Pelzer, F5 Networks, Inc.]

Thank you, Dennis. My name is Frank Pelzer, and I'm very excited to discuss with you today our fiscal 2018 Q3 results and Q4 outlook. Q3 marked a return to product revenue growth, as we had another quarter of solid execution and delivery of results. We continued to see growing momentum with our software offerings, particularly solutions for multi-cloud architectures, and our services business delivered another quarter of strong revenue and profit.

Third quarter revenue was $542 million, up 4.7% year-over-year and came in above the midpoint of our guided range of $535 million to $545 million. GAAP EPS of $1.99 per share was above our guidance of $1.79 per share to $1.82 per share. This beat was largely driven by strength in revenue, expense discipline and a lower-than-expected effective tax rate. Non-GAAP EPS of $2.44 per share was also above our guidance of $2.36 to $2.39 per share.

In Q3, product revenue was $239 million, up 1.6% year-over-year and accounted for 44% of total revenue. Software was approximately 15% of product revenue and grew 24% year-over-year. Systems revenue made up approximately 85% of product revenue and declined 1.5% year-over-year. Services revenue was $303 million, up 7% year-over-year and represented 56% of total revenue.

On a regional basis, Americas grew 3% year-over-year and represented 56% of total revenue. EMEA revenue grew 8% year-over-year and accounted for 24% of overall revenue. APAC revenue, which accounted for 15% of total, grew 8% year-over-year. And Japan, at 4% of total revenue, grew 4% from a year ago.

Sales to enterprise customers represented 64% of total revenue during the quarter. Service providers accounted for 19% of total revenue and government sales were 17%, including 7% from U.S. Federal.

In Q3, we had five greater than 10% distributors: Ingram Micro, which accounted for approximately 17% of total revenue; SYNNEX Corp. and Tech Data, which each accounted for approximately 11%. And Arrow and Westcon each represented approximately 10% of revenue.

I will now discuss our operating results. GAAP gross margin in Q3 was 83.2%. Non-GAAP gross margin was 84.5%, in line with our expectation. GAAP operating expenses of $299 million were at the lower end of our $297 million to $307 million guided range. Non-GAAP operating expenses were $265 million. Our GAAP operating margin in Q3 was 27%, and non-GAAP operating margin was 36%. Our GAAP effective tax rate was 20.4%, lower than expected due to tax benefits associated with our stock-based compensation expense in the quarter. Our non-GAAP effective tax rate was 23.3%.

Let's now discuss the balance sheet and other results. We generated $182 million in cash flow from operations, up 12% year-over-year, which contributed to cash and investments totaling over $1.4 billion at quarter-end. DSO at the end of the quarter was 49 days, flat with previous quarter.

Capital expenditures for the quarter were approximately $20 million, driven by our build-out of our new headquarters and international facilities expansion. Inventory at the end of the quarter was approximately $31 million.

Deferred revenue increased 9% year-over-year to just over $1 billion, driven by continued high-maintenance renewal rates. We ended the quarter with approximately 4,475 employees, up approximately 90 people from the prior quarter. In Q3, we purchased approximately 900,000 shares of our common stock and an average price of $166.22 per share, for a total of $150 million.

Now let me discuss our guidance for Q4. Based on strengthening pipeline and discussion with our sales organization, we see continuing momentum in the business as we close out the fiscal year. We expect to deliver another quarter of solid revenue growth with continued strength in product revenue. For the quarter, we are targeting revenue in the range of $555 million to $565 million.

Today, we announced an initiative to further align spend with our transformation to a leading provider of multi-cloud application services. Specifically, we will be accelerating investment in our roadmap and market development efforts in the fastest-growing areas of our business: cloud and security. As a result, we expect to take a restructuring charge in the range of $23 million to $25 million in Q4 that is reflected in our GAAP expense estimates. We do not anticipate that this action will impact our Horizon 1 or Horizon 2 financial guidance that we laid out for you in March.

In Q4, we expect GAAP gross margins of approximately 83%, including $5 million of stock-based compensation expense and $2 million in amortization of purchased intangible assets. We anticipate non-GAAP gross margins of approximately 84.5%. We estimate GAAP operating expenses of $317 million to $329 million, including approximately $34 million of stock-based compensation expense, $23 million to $25 million in restructuring expense, and $0.8 million in amortization of purchased intangible assets.

We expect a GAAP effective tax rate of approximately 25% for the fourth quarter and a non-GAAP effective tax rate at or around 24%. Our Q4 GAAP earnings target is $1.77 to $1.80 per share. Our non-GAAP earnings target is $2.61 to $2.64 per share.

On a final topic, I'm happy to report that my first few months as F5's CFO have gone very smoothly. I've had the opportunity to work with all areas and levels in the business and have been very impressed by the high quality and depth of knowledge of all F5 employees, particularly our world-class finance and accounting team. I would like to thank everyone for their warm acceptance of me to the organization and their tireless efforts in building a fantastic business.

With that, I will turn the call over to François.

[François Locoh-Donou, F5 Networks, Inc.]

Thank you, Frank, and good afternoon, everyone. During the third quarter, we saw continued momentum across the business with product revenue returning to growth. Software revenue continues to expand, driven by deployments in public and private cloud as our customers increasingly look to support and protect their applications across multi-cloud environments. We also saw strong demand for our security solutions, protecting enterprise customers against application-based threats.

Our software revenue continues to expand, growing 24% year-over-year. The pace of ELA and VE subscription software deals accelerated in Q3 as customers continued to embrace flexible consumption models, a trend we think will be important in driving adoption of our new cloud offerings, including our recently introduced BIG-IP Cloud Edition.

While Cloud Edition was just released to market at the end of May, we are already seeing strong interest and pipeline across the theaters. The early feedback from customers who purchased the product in Q3 confirms our view that right sized application services for every app opens up a large set of use cases that were not previously well addressed by existing software ADC offerings. We expect momentum for Cloud Edition to continue to build and that it will be a meaningful driver of software growth in FY 2019 and beyond.

In addition, we are seeing our customers increasingly choose to deploy a blend of both iSeries systems along with software in multi-cloud environments. Customers continue to utilize F5 security, application services and orchestration to seamlessly manage workloads across these hybrid environments. Our services business had another solid quarter with revenue up 7% year-over-year and deferred revenue of $1 billion. This team provides unparalleled customer support creating a significant differentiator and driving customer satisfaction.

The value of our services capabilities will only grow as the complexities associated with multi-cloud deployments become more prominent with our customers. We've shown strong execution during the third quarter for software solutions across all deployment environments with strength in public cloud both in Bring Your Own License and utility-based consumption. We also saw continued sequential growth for Enterprise License Agreements and subscription offerings. These offerings provide flexibility in procuring and deploying our virtual editions, leading to software expansion in service provider and enterprise accounts.

For instance, our ability to structure an ELA at a large U.S. financial services company helped create a high-capacity DNS infrastructure. The policy-based DNS functionality provides resiliency against outages across regional hubs. The deployment works across the three major clouds allowing the customer to choose the right cloud provider for the task at hand. This ELA is part of a multi-cloud software infrastructure and the customer continues to buy hardware systems to support a hybrid environment.

The traction we are seeing in software is augmented with the early success of BIG-IP Cloud Edition, which we officially launched on May 31. As a reminder, this release improved per-app visibility, analytics and auto scale capabilities. The solution provides app owners a virtual application delivery controller that can apply and automate policy when developing, deploying and securing applications across public and private clouds.

A large online services company in Asia purchased Cloud Edition to automate application deployment and shorten scale-out time. Utilizing BIG-IQ functionality paired with Cloud Edition, the customer was able to auto scale instances at the app level with analytics and seamless interoperability with other F5 solutions.

Application Protection continues to be a driver of security solutions with good momentum in our WAF offerings. A leading independent research firm identified F5 as a WAF leader with multiple consumption models, including the traditional Application Security Manager, Advanced Web Application Firewall and Silverline-managed service. In the first full quarter of sales, Advanced WAF is showing strong adoption from both new and existing customers. The operational ease of configuration and deployment is attracting new stand-alone security buyers.

A great example of this momentum in security is a competitive win at a European web hosting company, driven by our Advanced Web Application Firewall. The customer deployed Advanced WAF to protect their website portals and safeguard their brand reputation from application level compromised by sophisticated layer 7 DDoS attacks. The sales team participated in a competitive evaluation and demonstrated protection from bot-based attacks and superior behavior-based protection to catch subtle application layered DDoS attempts.

Highlighting our stated objective of offering stand-alone security products to a security buyer, today, we are introducing F5 SSL Orchestrator. This dedicated security solution allows ease of deployment and configuration for enterprise customers that demand orchestration with high performance decryption/encryption and steering of SSL traffic. This product gives customers a security appliance offering dynamic service chaining across the security infrastructure.

Consistent with our approach presented in our Analyst & Investor Meeting in March, we will continue to expand our stand-alone security portfolio and, today, we also announced the availability of F5 Access Manager. Core enhancements include protection of sensitive data with adaptive authentication while providing access for authorized users, devices and APIs, guarding against pervasive threats such as man-in-the-middle attacks. Access Manager enables organizations to bridge on-prem app functionality to the cloud, effectively integrating with Identity-as-a-Service solutions to support evolving heterogeneous environments.

As we outlined over the past year, we are evolving to a multi-cloud application services company that will reach every app anywhere. With this in mind, we are realigning resources to better position F5 for 2019 and beyond. Today, we are taking steps to notify some employees that their roles are under consideration or will be eliminated in order to accelerate our hiring in geographic sales expansion, new sales go-to-market motions, multi-cloud software development and digital transformation initiatives. Our objective with these decisions is to further align our workforce with a long-term strategy and accelerate the transformation that we outlined in our Analyst & Investor Meeting earlier this year.

The long-term first vision set forth is seeing significant traction with continued momentum in software and security sales. Customers continue to view our solutions as mission-critical in hybrid environments as they deploy incremental workloads dynamically, both on premise and in-cloud environments. The expansion of our software asset portfolio and stand-alone security products positions us as the leader in multi-cloud application services.

Before moving on to the question-and-answer session, I wanted to highlight three key additions to the leadership team. First, I am excited to announce that Chad Whalen has been promoted to Executive Vice President of Worldwide Sales. Chad joined F5 18 months ago and has built up our cloud sales team, while significantly deepening our partnerships with Microsoft Azure and Amazon Web Services. Chad also brought to F5 a depth of experience that spans complex, large enterprises to fast-moving start-ups. His past leadership roles included Fortinet, World Wide Packets, Jasper and Ciena. Chad brings a combination of cloud, security, IoT and service-provider expertise that we will leverage in our transformation to become a multi-cloud application services leader.

We were also pleased to announce on July 11, that Mary Gardner joined the F5 team as our new Chief Information Security Officer. Mary is a seasoned security leader with extensive experience in the health and finance sectors, where the protection of highly sensitive customer data and compliance with stringent regulations are business-critical issues. Prior to F5, Mary has held security leadership roles at Seattle Children's Hospital, Fred Hutchinson Cancer Research Center and kept information and networks safe at Port of Seattle and Washington Mutual, JPMorgan Chase.

Another important addition to our leadership team is James Feger who joined this month as General Manager for our service provider business. James comes to us after 14 years at CenturyLink, where he held multiple leadership roles supporting the design and operations of their network architecture, including his most recent role as Vice President of Network Virtualization. His hands-on insight into the challenges and opportunities service providers face as they roll out 5G, NFV and IoT services will be invaluable to F5 as we expand our reach and role in these environments.

I would like to welcome Chad, Mary and James to their roles on the F5 leadership team. As always, I would like to thank the entire F5 team and our partners for their efforts during the third quarter.

With that, we will now hand the call over for Q&A.

[Operator]

Thank you. We will now begin the question-and-answer session. Our first question comes from Samik from JPMorgan. Your line is open.

[Samik X. Chatterjee, JPMorgan Securities LLC]

Hi. Thanks for taking my question. I just wanted to start off with a question on the restructuring that you announced today. How should I think about the payback on that kind of restructuring? Is it sort of the intention here let's say is to sort of improve margins on the systems product? Or how should I think about impact on the financials longer term?

[François Locoh-Donou, F5 Networks, Inc.]

Thank you, Samik. Well, the first thing I'd say about the restructuring is that I genuinely don't like having to make these decisions because ideally and philosophically we would like to embark every employee that's been part of the journey with F5 into this exciting future that we're building with the company. The executive team has taken immense consideration on this because we know that we are making decisions that impact the lives of many of our colleagues and friends.

That being said, we are very focused on the transformation of F5 into a multi-cloud application services leader, and as a result, there is legacy spend that we have that is less relevant for the future than it has been for the past, and we are shifting our focus to the growth areas of F5, and specifically, we are intensifying our investments into software and multi-cloud technologies, in new go-to-market motions, and also in building the necessary digital infrastructure that enables those go-to-market motions. And so today's restructuring is really not about cost-cutting. It really is about realignment of resources towards these areas and accelerating the execution of our strategy.

In terms of how you should think about this action as it relates to long-term financial model, it's all very consistent with what we shared at our Analyst & Investor Meeting in March, and so this action has no implied change in our Horizon 1 and Horizon 2 guidance, so this is FY 2019, FY 2020 and also FY 2021, FY 2022.

[Samik X. Chatterjee, JPMorgan Securities LLC]

Got it, got it. That's helpful. And then just a follow up, you mentioned that you're seeing good traction on your stand-alone security products. Can you maybe share any kind of metrics in terms of either customer count or anything like that so that we can track your progress on that front? And also, are your leaders thoughts that you can sort of pursue that opportunity organically or are you open to sort of looking at maybe bolt on acquisitions to bolster your capabilities on that front?

[François Locoh-Donou, F5 Networks, Inc.]

Samik, I'll start with the latter part of your question. In terms of acquisitions I think we've touched on this before. I've said that I consider acquisitions to be a potential tool in the execution of our strategy as a technology company. If and when we find that there's an opportunity that makes sense, we will execute on that. And the key for me is that we continue to be disciplined in our investments, whether they be investments in organic innovation or potential investments in inorganic innovation in the future, that we take a very disciplined approach to both. And that's part of what you're seeing in our actions today.

In terms of the tractions that we're getting with our new stand-alone security offerings, we don't disclose customer counts, but I can tell you that the new stand-alone security solutions that we have announced we have already won a number of customers with those including a number of customers that are net new customers to F5. And the thing that is for me a significant sign of the traction we're getting there is in a number of these deals we're winning with our SSL orchestration solutions or our Advanced WAF solutions, we are not competing with any ADC vendors. We're really only competing with traditional or next-generation security vendors and our win rate is very strong.

As a good example of that is if you take our SSL Orchestration solution we've just released, it really is a use case that is absolutely critical to the security infrastructure, largely because most of the traffic now is encrypted, and sort of traditional security appliances are not very efficient at doing this encryption/decryption work in addition to the security service they have to offer.

And so in this case, actually, F5's hardware, security hardware, is extremely efficient than encryption/decryption and we marry that with an intelligent policy-based chaining of security services. And that allows us to provide a service chain across the full security stack and really nobody else can do that. So that's just a great use case for how our stand-alone security solutions are performing and it is absolutely in line with our strategy to be the leader in application security.

[Samik X. Chatterjee, JPMorgan Securities LLC]

Got it. That's helpful color. Thank you. Thanks.

[Operator]

Our next question comes from Sami Badri from Credit Suisse. Your line is open.

[Sami Badri, Credit Suisse Securities (USA) LLC]

Hi. Thank you for the question. I was hoping if you could give us maybe potentially an attach rate of the software and security revenues to specifically hardware sales in the quarter. And if you cannot really specifically answer that question with a tangible number, maybe you could give us an idea of this trend this quarter versus prior year. And then I have a follow-up after that.

[François Locoh-Donou, F5 Networks, Inc.]

Sami, I don't think we can give you an attach rate specifically. What I think we can share with you is two things. One is you continue to see growth in our software essentially in line with what we shared at the investor meeting, that software would grow in the mid-20s for the year and we're confident this is essentially where we're going to land. And that's true across both our software growth in ADC and our software growth in security. I think that has been the consistent trend over the number of quarters.

The other thing we can share with you is a large number of deals, even in security, I would say, a growing percentage of our business even in ADC, sorry, is actually driven by security use cases. And so we don't break that out and we don't quantify that, but I'd say the traction in security is growing both in our ADC business as well as in our stand-alone security business.

[Sami Badri, Credit Suisse Securities (USA) LLC]

Got it. Thank you. And then, at the Analyst Day, there were some comments alluding to an as-a-service product and the business model shift, et cetera. And I was hoping you kind of give us a little bit of an update around that and maybe any potential milestones or maybe just like a change of mind or anything like that? Could you just give us some color on that?

[François Locoh-Donou, F5 Networks, Inc.]

Yes. Sami, we offer today a managed service where we essentially redirect traffic from some of our customers to scrubbing centers that are largely in Equinix data centers. And then, we perform a number of services in these scrubbing centers. And that managed service is Silverline and it continues to grow. We've added a number of customers again in the quarter.

In addition to that, we did say that in 2019 we would be bringing to market a solution we call F5-as-a-Service, which is a – it's a complete self-serve model that would be hosted in a public cloud and would address all of the DevOps buyers that want to go to a pure public cloud buying motion. We remain on track for that solution in 2019. We haven't announced the date yet, and we will as we get closer to delivering on that.

[Sami Badri, Credit Suisse Securities (USA) LLC]

Got it. Thank you.

[Operator]

Our next question comes from Alex Henderson from Needham. Your line is open.

[Alex Henderson, Needham & Co. LLC]

Great. Thanks. I was wondering if you could just give us some qualified sizing around the growth rate in the security business. I know you don't want to break out the dollar value of it, but it would be helpful if you could at least talk about roughly what the rate of change in that business is. And then second, if you could talk a little bit about what portion of your business is coming from SaaS or cloud-related footprint that would be helpful as well?

[François Locoh-Donou, F5 Networks, Inc.]

Alex, thank you. I'm going to disappoint you on both counts because I can't give you numericals. And it's not just that we won't, but let me start with security. In security, our business is both some stand-alone security use cases as well as security-driven use cases in our ADC business. And sometimes breaking that out is actually quite subjective on our part. And this is one of the reasons that we don't disclose that information. I can, on the other hand, share with you that security as a whole is one of the faster growing areas of our business. So it is growing faster than the aggregate revenue, if you will.

As it relates to public cloud, again, we don't today – we may in the future, but we don't today purely break out public cloud revenues. Public cloud is actually the fastest-growing part of our business. And we continue to drive customers to public cloud, both buying their license and instant sharing it in public cloud or buying into our systems on a utility basis. I've shared that we're now billing millions of hours per quarter on all the major public clouds. And our cloud edition we just released, actually, we expect to accelerate that because it makes it easy for customers to burst some of their applications into a public cloud and leveraging our auto-scale capabilities. So that's where we see significant acceleration of our software solutions in the future. But I just can't quantify it for you yet.

[Alex Henderson, Needham & Co. LLC]

Okay. Could I follow-up, though? You last quarter had given positive comments on both your million-dollar deals as well as, I think the term you used was accelerating pipeline of deals that you're chasing. Can you at least qualify something around that? Is there any change? Or is there any reason why didn't mention that this time around?

[François Locoh-Donou, F5 Networks, Inc.]

No. There's no reason we didn't mention it, Alex. As we kind of predicted last quarter, we saw a growing number of seven-figure software deals. These are typically ELAs, Enterprise License Agreements. And we're seeing, we only released these offerings about nine months ago. And sequentially every quarter over the last three quarters, we have seen the traction in pipeline with this consumption model growing with our customers. And this quarter, we had a record number of such deals on software and on these Enterprise License Agreements. They are particularly important to us because we can land customers on these deals and over time expand them as they add to their initial subscription. So, generally pretty excited about what's happening with the large million-dollar plus software deals that we are seeing.

[Alex Henderson, Needham & Co. LLC]

So that's a strong number in the quarter and strong pipeline? Just to be sure I got it right.

[François Locoh-Donou, F5 Networks, Inc.]

Correct.

[Alex Henderson, Needham & Co. LLC]

Okay. Thank you. I'll cede the floor. Thank you.

[François Locoh-Donou, F5 Networks, Inc.]

Thank you, Alex.

[Operator]

Our next question comes from Rod from Goldman Sachs. Your line is open.

[Rod Hall, Goldman Sachs & Co. LLC]

Yeah, hi. Thanks for the question. I appreciate it. I guess I want to ask kind of a question about the progress of software again. But the real question I have is, when you guys think you might release some KPIs that would help us quantify this so that we can understand either maybe what proportion of product revenue the software sales are or some other KPI that you've got in mind that would help us track actual quantifiable progress on that strategy. So that's, I guess, one question.

Another one is related to that, which is deferred revenue, which was flat quarter-on-quarter. And I guess we expect the software products to be pretty small at this point, but that deferred revenue suggests there's not a whole lot of movement in the direction of software yet from the point of view of the overall revenue. So I'm just curious. Is that true or is there a bunch of some more software deferred revenue in there than we think, and if we could see the breakdown, we would see more progress? Thanks.

[Francis J. Pelzer, F5 Networks, Inc.]

Sure. Rod, it's Frank. Let me take that one. So, on the KPI question, I would say as the business becomes more material, we'll consider certain KPIs that you can continue to track. At this point we're talking about the growth rates that we've experienced in the business, particularly on the software side, as an indication of the strength that we're seeing in that business.

I think on your second question on the deferred revenue, it was actually up I think close to 7%, 1.7% quarter-over-quarter but 7% year-over-year. And we talked about that's really still the continued strength that we've seen in the maintenance on the ELA side, and it's just a smaller portion of our total revenue. And so, it really doesn't have a major move yet in the deferred revenue piece.

[Rod Hall, Goldman Sachs & Co. LLC]

Okay. Frank, can I follow-up? The other thing we noticed is APAC and Japan. The Japanese decline was lower. APAC growth is better. Just curious if you guys have any further color on what drove those continued changes and trajectory there. It seems like things are improving.

[Francis J. Pelzer, F5 Networks, Inc.]

I think it's positive market dynamics, particularly in some emerging economies that we haven't necessarily had as much presence in before, particularly China and India. And so we were really excited to report that kind of growth, and I think we've got a really strong team that's executing quite well.

[Rod Hall, Goldman Sachs & Co. LLC]

Great. Okay. I appreciate it.

[Operator]

Our next question comes from Jason from William Blair. Your line is open.

[Jason N. Ader, William Blair & Co. LLC]

Yes. Thank you. François, in our VAR checks, we picked up some challenges with ELA pricing with certain large enterprise accounts. Can you talk about how some of the pricing discussions are playing out? I mean, it sounds like you're positive on the progress there. But are there some kinks that still need to be worked out?

[François Locoh-Donou, F5 Networks, Inc.]

Hi, Jason. Let me start with the latter part first. This is the first year of us offering ELAs and subscriptions, and so no doubt there is an element of learning as we go through the first deals and kind of readjust this as we learn more and also as the volume of these deals continues to increase. That being said, there is not a particular challenge on pricing that we've picked up in those deals. In fact, if anything, if we just look at discounting levels, we think the discounting levels in these types of deals are less than in traditional perpetual software deals. So we're pretty encouraged by the early trends around what we're seeing in terms of customer adoption. So there is not a challenge specifically with ELA or subscription deals.

[Jason N. Ader, William Blair & Co. LLC]

Okay. I guess what I was talking about is – what I meant by challenges is, we just heard that in some of the – there were some transactions where customers just pushed back on the pricing. So was that it was too expensive, not – it's consistent with what you said, that there's not as much discounting. So maybe we just maybe picked up a couple of isolated instances, but it sounds like you're feeling good about that learning process and adjusting as necessary.

[François Locoh-Donou, F5 Networks, Inc.]

Yes, we're feeling very good about it, Jason. There's always an element of course of negotiation with our customers, but we're feeling very good about the pricing, but also the consumption model. Our ELAs are unique in that we allow customers to consume and add sort of consumption or throughput to their licenses during a period of time and then we true it up after that. And once our customers really understand the consumption model that we're giving in these ELAs, they realize there's tremendous value in these ELAs and the adoption is pretty strong. So if your question is, are we losing ELA deals because of pricing? The answer is absolutely no.

[Jason N. Ader, William Blair & Co. LLC]

Okay. And then just one quick follow-up, did you say systems were down 1% year-over-year? Is that what I heard, revenue?

[Francis J. Pelzer, F5 Networks, Inc.]

Yes, 1.5%.

[Jason N. Ader, William Blair & Co. LLC]

Okay. And how did that compare to your expectations?

[Francis J. Pelzer, F5 Networks, Inc.]

It was in line with our expectations.

[Jason N. Ader, William Blair & Co. LLC]

That's it for me. Thank you, guys.

[Operator]

Our next question comes from James Fish from Piper Jaffray. Your line is open.

[James E. Fish, Piper Jaffray & Co.]

Hey guys, thanks for the question. I just wanted to first ask on the competitive dynamics because we didn't hear too much about that outside of essentially the stand-alone security space. Can you just give us an update on the landscape there as related to the last question regarding pricing, and especially as it relates to some of the private vendors like Cloudflare and the recent announcement from Cisco and Avi Networks?

[François Locoh-Donou, F5 Networks, Inc.]

Yes. Thank you, James. So on the competitive landscape we really like where things are going in the virtual ADC space. In particular, we're very happy with the traction we've gotten with our BIG-IP Cloud Edition. It's just been in the market for one month. We already have a substantial number of wins. And what's happening essentially James is we are offering things that have not been available in the market before. For the first time we are enabling applications teams to self-service on their ADC which is opening up new use cases. We're also for the first time enabling app teams to auto scale their solution.

So for applications that are bursty, that's a very important capability, one of the companies I mentioned in the script is an online services company in Asia. They really purchased Cloud Edition because they have naturally a bursty traffic. They have a sort of seasonable demand to their solutions, and so our ability to burst the capabilities and for them to really pay for only what they're using is absolutely critical. And all of that we're offering at the lower total cost of ownership than a traditional VE.

And so customers have not been able to get that from a vendor that has both the depth of features that we have and the world-class support that F5 brings to the table. And we see that as a substantial change in the ADC market, so we're very positive on our competitive position. And as I said before in terms of ELA and subscription deals, we're doing well there and we're not seeing a significant challenge from any of the other consumption models you mentioned.

[James E. Fish, Piper Jaffray & Co.]

Got it. That's very helpful color, François. Just one last one from me on the new F5 Access Manager. Correct me if I'm wrong, you were previously partnering with a leading provider that's cloud-based that essentially F5 was doing the off – the on-premise environment and the partner was doing the on-premise. Is this new product just integrating them more? Or did you come out with your own off-premise solution in this new release?

[François Locoh-Donou, F5 Networks, Inc.]

This new release, James, is really targeted at customers that want to deploy on-prem or want to deploy across multi-cloud. And so it allows customers to essentially augment their capacity from on-prem to a private cloud or a multi-cloud in a seamless way and really for them to auto scale the capability as they need it. So it's not affecting a particular partner. It's more that we are really truly obsessed with what our customers want to do next. And we're delivering an innovation in the way they want to consume the technology that they had been asking for.

And in fact, in some cases, because they didn't have that solution from F5, they were looking at potentially other solutions, either from start-ups or open source players. And we're now seeing that we are intercepting some of these proof-of-concepts and having significant win rate, because, ultimately, they want these solutions from a vendor that they trust and that has the capability to support them across multiple environments.

[James E. Fish, Piper Jaffray & Co.]

Great. Thanks.

[François Locoh-Donou, F5 Networks, Inc.]

Thank you, James.

[Operator]

Our next question comes from Catharine from Dougherty. Your line is open.

[Catharine Trebnick, Dougherty & Co. LLC]

Thanks for taking my question. Just one question on the service provider market, François. What are the opportunities you're really targeting in 2019? Your revenue's been hovering about 19% to 21% aggregate. And I'm just curious of what you think the opportunities are going forward in the carrier segment.

[François Locoh-Donou, F5 Networks, Inc.]

Thank you, Catharine. So I'll speak a little bit short-term and longer-term. In the short run, we continue to see a great traction with security, firewall solutions, carrier-grade firewall solutions especially in the service provider market, because the increase in traffic – in mobile traffic in particular, requires the scalability that our hardware, specifically our VIPRION solutions provide. And so that's going to continue to grow.

And then, there's a number of use cases that are pretty immediate short-term that are also driving demand for our hardware, things like IoT with their high transactional-type applications drive significant demand for our hardware in the carrier space. If we take a more of a longer-term perspective, a number of carriers are looking to virtualize their infrastructure. And the more they move to virtualization, the more they need solutions for, a) traffic management and, b) security. Those two challenges become more important as they virtualize their environment. And F5 is a leading player in both areas.

And so we're taking really more deliberate steps and more strategic investment in these areas as evidenced by us bringing onboard James Feger and some of the announcements we've made around what we're doing in the NFV space really to make sure we are aligned with these 5G architectures, with these virtualized architectures, because our customers are asking for more from F5 as a partner as they evolve their architectures.

[Catharine Trebnick, Dougherty & Co. LLC]

All right. Thank you. And just a quick product question. Orchestrator's been out for almost two years. Is this a newer feature functionality that you're speaking about today?

[François Locoh-Donou, F5 Networks, Inc.]

No, that's a great nuance. We've had an SSL Orchestrator solution recently, but there were two things with it. One is it required a significant level of, if you will, professional service or customization from F5 to make the solution work in a specific environment. And two, it was only consumable when attached to an ADC. The solution we're now releasing is going to significantly expand the addressable market for F5 in two ways.

Number one, a lot of the customizations that we built with our customers over the last couple of years, we've really now productized all these customization. And therefore, the consumption motion or the ease of deployment is much greater for our customers. And so we would expect to see a lot more velocity in the deployment of these solutions. And number two, we've made substantial changes to the solution with things like ease of configuration, that make the solution consumable by a security buyer not attached to an ADC. And that allows us to address a new part of the market, playing purely with security vendors.

[Catharine Trebnick, Dougherty & Co. LLC]

Okay. Thank you very much.

[Operator]

Our next question comes from Mark from D.A. Davidson. Your line is open.

[Mark Kelleher, D.A. Davidson & Co.]

Great. Thanks for taking the questions and congratulations on the year-over-year product growth. I want to ask about that. Have we reached an inflection point where that number should now be increasing each quarter? Another way to ask that, is the software growth now sufficient to outgrow the decline in the systems business?

[François Locoh-Donou, F5 Networks, Inc.]

Well, Mark, a couple of things. One is I think we are – our view is unchanged from what we shared with you in March that our expectation is that in 2019 what we will see – 2019 and 2020, it was said we would see low to mid single-digit growth overall that will most likely be low in 2019 and mid in 2020, in part, because of a, I'd say, small decline in the systems business and continued strong growth in the software business. All the indicators we've seen since March tend to validate that that is what I think we'll see in 2019.

One needs to be careful about taking too much sort of conclusions from a single quarter because now that we're disclosing our software number, which is still a relatively – it's only 15% of product revenue, so it's still a relatively small number. Quarter-to-quarter that can be lumpy. We can see a high software growth quarter and a low software growth quarter, but when you look at it on an annual basis, the trends that we've talked are really going to continue.

[Mark Kelleher, D.A. Davidson & Co.]

All right. And just as a follow up to some of the growth numbers, if we look at Enterprise, Service Providers and Government, if I did the math right, you had a very strong Government quarter, kind of offset the weakness in the other two, which is a reversal of the March quarter. What can we expect in terms of seasonality from those three segments going forward?

[François Locoh-Donou, F5 Networks, Inc.]

So, Mark, again, I wouldn't take too much from the quarter-to-quarter iterations. Federal has a sort of natural cycle where we see typically stronger Federal in the latter half of the year and less in the first part of the year. Service Provider generally is a segment that's fairly lumpy for us, and I think not just for us but for most vendors that are in that space. I think North American CapEx in particular this quarter was a little soft. I think we're seeing that in our Service Provider numbers, but I wouldn't be able to predict to you where we're going to see seasonality in the Service Provider space.

[Mark Kelleher, D.A. Davidson & Co.]

Okay. Great. Thanks.

[Dennis Melton, F5 Networks, Inc.]

Operator, can we do one last question, please?

[Operator]

Our next question comes from James from Morgan Stanley. Your line is open.

[Meta A. Marshall, Morgan Stanley & Co. LLC]

Great. Thanks. This is Meta Marshall for James. Sort of following up on Catharine's question in the Service Provider business, typically that's been around 20% to 25% of the business. With kind of the enhancements that you've made, is there a target percentage of the business that you see being Service Provider? And then just second question, the EMEA business was kind of particularly strong. Do you think that that was some of getting past GDPR? Or was there a particular trigger? Or just weak compares? Thanks.

[François Locoh-Donou, F5 Networks, Inc.]

Thank you, Meta. I'll start with Europe, we're pleased with the growth we had in Europe year-over-year. I think some of that – if you recall, we said last fall that we were making a realignment of our resources in Europe to address where we thought there was better growth opportunities, and I think to some extent we're seeing the benefit of that play out in the growth. And the team in Europe actually has executed very well over the last few quarters.

We are cautious about Europe because we're still seeing – the macro uncertainty is not gone completely, specifically with the UK and Brexit. So we don't want to get too carried away with what we're seeing in Europe, but we're pleased with the performance this quarter and specifically the execution of our teams.

In the Service Provider space, Meta, we don't have a specific target for a percentage of our business because over time we expect our Enterprise and Fed business to continue to grow, and we expect our Service Provider business to grow as well.

The one thing I would say is in the Service Provider space, especially as you go through architectural changes, changes in the amount of business happen over a period of time. And right now we're making I think strategic and deliberate investments in that space that will play out over our Horizon 1 and Horizon 2, especially as it relates to NFV.

[Meta A. Marshall, Morgan Stanley & Co. LLC]

Got it. Thanks.

[François Locoh-Donou, F5 Networks, Inc.]

Thank you.

[Dennis Melton, F5 Networks, Inc.]

Thank you, everyone.

[Operator]

Yes, I'm sorry.

[Dennis Melton, F5 Networks, Inc.]

Oh, no. I was saying that's our last question. Thank you. Operator?

[Operator]

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