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Juniper Networks (NYSE:JNPR)

November 15, 2011 10:00 am ET

Executives

Kathleen Nemeth -

Robyn M. Denholm - Chief Financial Officer, Executive Vice President, Member of Concerns Committee and Member of Stock Committee

Analysts

Unknown Analyst

Unknown Analyst

Okay. Thanks, everyone, for joining us in this session. We're happy to have in this session Juniper Networks. And with us, we have Kathleen Nemeth from Investor Relations and Robyn Denholm from -- well, the Chief Financial Officer. Thank you for attending our conference. And Robyn's going to do a few slides, and then we'll take some Q&A.

Robyn M. Denholm

Okay. Thanks, Nikos [ph], and good morning, everyone. I just wanted to make sure I brought your attention to the Safe Harbor slide before I start the presentation. Obviously, we'll make some forward-looking statements here and all the risks and uncertainties are on the filings that we've recently published.

So in terms of Juniper, what I wanted to -- go back 1 slide. What I wanted to start off with is really the new network. So we've been talking about the new network for a few years now. The 2 key trends that we're focused on in bringing the new network to life is around the mobile Internet and cloud computing. And what you can see is that we're both transforming the experience as well as the economics. So everything that we do at the company is focused on helping service providers and enterprises with their cost in terms of their networking cost, as well as driving the experience for users, both in terms of the service provider users and the enterprise users. And what you can see is everything in our portfolio of products, as well as our solutions are actually aimed at these areas.

So if you look at our strategy this, to me, is our strategy on a slide. What we do as a company is we focus our R&D effort on the key architectural transitions that happen in networking over the a prolonged period of time. And we look at those 3 and 5 years out. An example of that is what we've done in the data center. We've just recently, in the last quarter, actually brought to market our QFX product, our QFabric product. Those were many years in the making. The architectural transition that we foresaw were having large-scale data centers that are 10 gig inflection point as well as having massively scaled data centers with service and storage devices and that type of thing. So that's an example of an architectural transition. What we're doing in the core, with PTX and our next generation of core routers T4000 is another example of an architectural transition. So we actually put the R&D dollars into those architectural transitions. We then expand the footprint, the systems footprint, and we're about platforms as well as software in the network.

And then the third pillar of our strategy is actually driving up the stack with software across the board, whether it's on the device, in the network or across the network. And we have 3 developer communities both in terms of the Junos OS, the Pulse, which is on the client side and the Space, which is the management layer.

In terms of the new products that we're bringing to the market, we actually have been in a heavy R&D cycle over the last 3 years, and these are the products that are coming to market. There are obviously others, but these are the main ones. So you can see the QFabric products, they're out now as of the third quarter and getting very good customer receptivity in terms of the architecture and what we're doing there. Mobile Next is also out. That just started shipping in the second quarter. It's a software on top of our MX 3D platform that we have on the Edge router side. PTX will start shipping in the first quarter of 2012, and the T4000 is on track to ship in the fourth quarter with revenues in the first quarter.

So in terms of our year-to-date revenues, we are doing very well. Third quarter year-to-date, our revenues are up 15% year-over-year, and we had solid growth in all 3 geographies. If you look at our operating margins, they're also pretty good in terms of profitability, and our product revenues are up in MX, 70% year-over-year, EX 16% year-over-year, and SRX was down slightly 2% year-over-year. If you look on a year-to-date basis, product revenue for routing is up 19% year-over-year and switching product revenue is up at 30% year-over-year and a slight decline in our security area.

If you look at what we're doing in our 2 markets, Enterprise is up over 11% year-over-year. And if you look at our Service Provider business, it's up 17% year-over-year. So pretty healthy results given the macro environment out there.

So in summary, we're very confident in the strategy that we're on. It's aligned to the markets. Our customers are embracing the technology that we're bringing to market. We do have disruptive innovation and it's generating momentum with those customers. And we're also executing well in the macroeconomic environment that's out there. We are pretty agile in terms of our cost base, and we have actually been making sure that we're investing for the long term as well.

Unknown Analyst

Okay. Thank you. Okay, thanks for that, Robyn.

Question-and-Answer Session

Unknown Analyst

I'll just ask a few questions following up on that. So you had a slide up there with the new products, if you look at the new products, which ones -- which one do you think is showing the most significant customer interest that would potentially generate the most positive results for you in 2012?

Robyn M. Denholm

We're pleased with the customer receptivity of all the new products, actually. Obviously, the PTX is not released yet. But even in early evaluations, the customers are quite pleased with it. So if you look at the products that -- the 4 new big products that we have coming out over the next period of time, the first 3 are driving significant architectural change, both in terms of QFabric, Mobile Next and PTX. The T4000, whilst it is a great leapfrog in terms of the core, in terms of performance for any platform that's out there today, it is a seamless upgrade with our T1600 Core Routers that are out there. So I would say the revenue ramp for the core is much more well-known to us given that we've been in that market for quite some time and this is actually the third generation of seamless upgrade that we've had. So I would say in terms of ramp-to-revenue, that's obviously the more predictable, the more well known. In terms of the QFX, we've had very good customer receptivity to QFabric. We've actually already announced some key design wins with some customers Deutsche Boers, Bell Canada, Terra and also Thomson Reuters. And I think those 4 are actually examples of many other customer engagements that we have in terms of discussions at this point, where some customers are actually deploying the full QFabric straight out of the gate like Bell Canada, and then others are actually taking the QFX3500 node, the 10-gig top-of-rack node that's fabric-enabled that they can then deploy the rest of the fabric solution over time, and some have indicated that they will do that. And others are actually deploying the QFX3500 and then not necessarily declaring at this point whether they will go full fabric over time. So we have varying degrees of customer engagement today on those products. But so far, we're very pleased with the results across the board.

Unknown Analyst

Okay. Just a question on terminology. You occasionally use the word design win and then customer, right? So the 3 or 4 design wins for QFabric, are these deploying customers or -- I'm just trying to understand the difference.

Robyn M. Denholm

Yes. So a design win for us is an award of actually either a bake-off, a competitive bake-off or an award of future business. It may not be an order straight on that way but it may be an indication that they are going to order at some future point. We look at some of the earlier signs of revenue in the future. So you will hear us talk about design wins for the new products in particular. If you look at MX, design wins preceded revenue, right? And so that's the cycle. You go from customer engagement, SRS and then design wins in terms of the cycle, and then obviously orders.

Unknown Analyst

Okay. On the QFabric product, given the -- if the product became commercially available recently, do you have enough feedback from the customers that are looking at it that the first iteration, in terms of hardware and features, is strong enough in the marketplace to be successful? Or are you getting some feedback, this is a great product but we would like the tweaks here and there and it might impact the deployment. What's the feedback you're getting on this first iteration that's in the market?

Robyn M. Denholm

Yes. I mean, clearly, it's still early days. But we're pretty pleased with the feedback. We obviously did some beta trials beforehand, and the feedback from early customers is pretty consistent with the feedback that we were getting through the beta trials. So overall, we're pleased with where we are at the moment. It's very early days still, obviously, from a sales-cycle perspective.

Unknown Analyst

Okay. Shifting gears, so the service provider router market, which you're one of significant players and it's a big part of your revenues, has consistently grown in non-recession years, 15% or better. And so far this year, it looks like we're going to hit that, at least through the first 3 quarters. We'll see what the fourth quarter does, but certainly double-digit growth in non-recessionary years. Do you see anything different for 2012? Obviously, there's macro risks. Europe might go on a recession, it might not. The U.S. might go on a recession, it might not. But in terms of what you're hearing from customers, assuming we have a non-recessionary environment, would there be anything structurally different that would make demand not grow at least double digit for the market?

Robyn M. Denholm

Yes. I think given obviously the exponential growth in traffic, there's a lot of fundamental demand there from a -- what makes routing grow in terms of both the quantity of traffic as well as the type of traffic with video increasing in terms of penetration. And again, coming back to my prepared remarks, mobile Internet and also cloud computing will continue to drive the traffic volumes over time. So in terms of the absolute growth rate, for 2011, we actually thought routing would grow at the beginning of the year when we were setting up our long-term model and our operating principles for 2011. We actually thought that the routing growth rate would be somewhere between 12% and 15%. We actually think, given the third quarter and obviously our guidance for the fourth quarter, that we're growing faster than the market for 2011 and we actually think that the range is actually less than what we thought it would be at the beginning of the year. So we think that this year is slightly lower than the 12% to 15% growth that we were talking about at the beginning of the year for the market growth rate. In terms of next year, it's a little bit too early to call the year, just given the changes in some of the carrier CapEx behavior in the second half of 2011.

Unknown Analyst

Okay, okay. So speaking about carrier CapEx in the most recent quarter, your book-to-bill was 1.2, very strong. On the other hand, a lot of the -- it was more -- you have a 6-month backlog on products, so it was more second-half weighted than normal, I would say, which led to the very strong book-to-bill, at least if I heard that right. What is it -- what do you think led to that? Are there certain products that are coming out or configurations that are coming out in the first quarter that customers felt the need to make sure they got in your order pipeline due to lead times or something? Why are they ordering more into the future than they've done in the past?

Robyn M. Denholm

Yes. I think the book-to-bill in the third quarter was actually definitely a highlight of the third quarter results. And it was, as you mentioned, quite a bit higher than usual. In fact, it was one of our highest book-to-bills that we've had at least in the time frame that I've been at the company for just over 4 years. So -- and if you look at that, the thing that was unusual other than just a straight out book-to-bill was there were couple of customers that actually ordered outside of the next quarter. So they were placing orders for us in the third quarter for delivery in the first quarter. None of that was tied to new product. It was all existing product. And on the call, I said it was mainly routing, and there was quite a bit of Edge routing in there. And that's the deployment of both new and existing design wins that we've had with our industry-leading platform in the MX 3D. So some of that, I think in the third quarter, we obviously saw a sequential decline in revenue. So some of it was timing in terms of wins. Some of the new deployment were slated to be actually start to roll out, so in the fourth quarter and going into the first quarter of next year. So in terms of the customers' motivation, I don't want to speak for our customers, but I think given that many of the -- some of it was tied to the new design wins, they wanted certainty of delivery for their deployments in terms of both new deployments that they were rolling out. So that's probably the closest in terms of why they were doing that. So certainty of delivery over when -- having the equipment when they needed it for the deployments and actually rolling it out then.

Unknown Analyst

Okay. Does anybody have any questions from the audience? All the way in the back there.

Unknown Analyst

Can you talk about the dynamics going to the network security market, your position versus Cisco and some of the other incumbents and this sort of generic move towards unified threat management?

Robyn M. Denholm

Yes. So the security market overall is evolving. So if you come -- go back to the 2 key industry trends that we're following, it applies to security just as it does to other parts of the network. So with the proliferation of devices in enterprises, bring your own device to work, that type of thing, what we're seeing is the need for very robust device security, and that's where our Pulse offering actually plays. And you may have seen, we've announced a couple of significant design wins with the service providers in that space, so one with AT&T in Q2 and a couple of others around the world. We also, last week, announced an Enterprise arrangement with IBM as well to take that same Pulse offering into Enterprises, and we are seeing quite a bit of receptivity with enterprise customers because it doesn't matter which CIO you talk to, the proliferation of different devices and not having a corporate-issued type of device actually creates a security challenge for CIOs. So that is where Pulse plays. The other end of that is the data center. So again, in mobile Internet, cloud computing. The data center, the high-end SRX was designed for high-scale traffic firewall for both the service providers, and we've seen good traction with high-end SRX with service providers around the security on the smartphone. What we are yet to see is that same penetration in the enterprise. We do have many features that CIOs are looking for, particularly in the data center around virtual security. So our vGW, our Virtual Gateway security provides security on a high-end SRX for the virtual machines within the data center. And so as we start penetrating the data center with both switching and obviously with QFabric, we expect that to increase in terms of volume as well from a security perspective. In terms of -- overall, the market in terms of security as I said is evolving in terms of those 2 key trends.

Unknown Analyst

Question over there?

Unknown Analyst

Yes. Just wondered if you could talk about R&D. You mentioned how you've had quite a few projects that have come to fruition. And as we look into 2012, what you're spending the money on and what you think the sort of run rate of R&D will be next year?

Robyn M. Denholm

Yes. I think we're very pleased with investments that we've made in terms of these large projects because you can see the fruits of those projects come to market over the last couple of quarters and then into early 2012. You can be assured that they're not the last products we'll ever bring to market. We are working on other products in terms of different parts of the market. Some of which we've talked about, so Pulse and the offerings around security space. We've talked about some of those. And there are other offerings that we haven't spoken about. So more to come on those at some future point.

Unknown Analyst

Recognizing the U.S. is only one part of your routing business, but do you think the T-Mobile deal and the Verizon strike had any meaningful noticeable impact on routing demand this year?

Robyn M. Denholm

Yes. I think it's hard to say whether any type of transaction, obviously, the consolidation in the service provider space is a trend that we've been anticipating for some time. I think it's inevitable especially when you're talking about cost per bit and the economics around driving volumes and the amount of traffic that's going through networks. So invest in the critical network infrastructure, you have to have scale in order to be able to do that. So the whole trend around consolidation in that space is something that we've been anticipating for quite some time. Whether that particular deal or not had any impact, I wouldn't say.

Unknown Analyst

On R&D and focus, the company recently hired Robert Muglia from Microsoft and is -- Bob, sorry. Okay. I don't know him personally so I just went with the press release. So the question I have is it seems with Junos Pulse and the creation of this new position, there's going to be more focus on software. Is there going to be a trade-off between the traditional routes of the company in ASIC and chip development and allocating more resources to software? Or do you think you can maintain both focuses and still hit the 25% operating margin target?

Robyn M. Denholm

I think one of the best-kept secrets about Juniper over time has been the software focus. I think creating the divisions has actually shone a spotlight on it. But actually, from the beginning of the company, we've had a strong focus on software. What Pradeep and the very early team at Juniper did was the developer, the colonel of the OS said actually, we're continuing to develop and have done over some time. So we have quite a large proportion of the R&D staff at Juniper that are software related. And so I think what Kevin's done with the organizational structure is actually help us focus in terms of the value added parts of the software. So not just sediments, the features and functionalities into the core OS, but also add on top of that other parts of the software area that adds value to customers and also obviously adds revenue and margin to Juniper. One of the examples of that which we don't talk about is some of the router services that we do with our platforms, both MX 3D and other router platforms where we actually have software that's employed in the network router services that's a different revenue stream. So today, we bundle that together in our IPG revenue. As we move forward, you'll then start to see some of that software revenue separately reported. So it's sort of like OS; Pulse, as we talked about in some of the security areas; and then other software applications that we've already been in market with and others that we'll bring to market that are specifically focused on value add on top of the system platform.

Unknown Analyst

Okay. One last question, gross margin, the CFO always gets the gross margin question, right. So if I look at 2Q and 3Q, the product gross margin has trended down a bit, and Cisco has been talking about being more aggressive in emerging markets in the router market, and the expectation is Huawei and Alcatel will try to be more aggressive in the future. Has routing seen its best days in terms of margin profile? Or do you still -- and the trend is down going forward? Or can this still be a stable gross margin business for Juniper?

Robyn M. Denholm

Yes. I -- our routing margins -- in fact, our margins overall, from a gross margin perspective, are actually very healthy. And if you look at what's happened over the last couple of quarters, the proportion of either SLT revenue or router revenue, in the case of the third quarter, was less at the proportion of total revenue than has been typically the case. And so that has been a slight headwind on the gross margin. The other is we have had some specific period costs in terms of inventory carrying charges that we've borne over the last couple of quarters. And so from my perspective, the margins, router and otherwise, are very healthy. I think innovation and gross margin go hand-in-hand. So when we're delivering solutions to customers that are actually 10x or in the case of PTX, 5x to 7x better than what any competitors have out there, either the performance in terms of any other products that are out there or actually use 1/3 or 50% of the CapEx of a competitor's solution, that actually creates great value to the customers. So even if you look at the QFabric solution, it might be slightly more in terms of the per box or per solution price. But what it delivers to the customer is many times less than what it would cost them with the competitive solution. So our viewpoint is that our margins are healthy because of the innovation and the value that we're delivering to our customers. And it's reflective of how high they are and will continue to be.

Unknown Analyst

Okay, with that, we've run out of time. Kathleen, Robyn, thank you for attending, and we hope to see you both next year.

Robyn M. Denholm

Thank you. Okay.

Kathleen Nemeth

Thank you.

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Source: Juniper Networks, Inc. Presents at UBS Global Technology and Services Conference 2011, Nov-15-2011 10:00 AM

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