F5 Networks (FFIV) John McAdam on Q2 2016 Results - Earnings Call Transcript

| About: F5 Networks, (FFIV)

F5 Networks, Inc. (NASDAQ:FFIV)

Q2 2016 Earnings Call

April 20, 2016 4:30 pm ET

Executives

John Eldridge - Director, Investor Relations

Andrew Reinland - Chief Financial Officer & Executive Vice President

John McAdam - President, Chief Executive Officer & Director

Karl D. Triebes - Chief Technical Officer & EVP-Product Development

John DiLullo - Executive Vice President of Worldwide Sales

Analysts

Alex Henderson - Needham & Co. LLC

Matt Robison - Wunderlich Securities, Inc.

Vijay K. Bhagavath - Deutsche Bank Securities, Inc.

Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc.

Ittai Kidron - Oppenheimer & Co., Inc. (Broker)

James Dickey Suva - Citigroup Global Markets, Inc. (Broker)

Mark Moskowitz - Barclays Capital, Inc.

Jayson A. Noland - Robert W. Baird & Co., Inc. (Broker)

Jess Lubert - Wells Fargo Securities LLC

Paul Silverstein - Cowen & Co. LLC

Operator

Good afternoon and welcome to the F5 Networks Second Quarter and Fiscal 2016 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 Mr. John Eldridge, Director of Investor Relations. Sir, you may begin.

John Eldridge - Director, Investor Relations

Thank you, Sam. Welcome, everyone, to our conference call for the second quarter of fiscal 2016. John McAdam, our President and CEO; and Andy Reinland, Executive VP and CFO, will be the speakers on today's call. The other members of our exec team are also on hand to answer questions following John and Andy's prepared comments.

If you have any follow-up questions, please direct them to me at 206-272-6571. A copy of today's press release is available on our website at f5.com. In addition, you can access an archived version of today's live webcast from the Events Calendar page of our website through July 20. From 4:30 PM today until midnight Pacific Time, April 21, you can also listen to a telephone replay at 866-474-1441 or 203-369-1499.

During today's call our discussion will contain forward-looking statements, which include words such as: believe, anticipate, expect and target. These forward-looking statements involve uncertainties and risks that may cause our actual results to differ materially from those expressed or implied by these statements.

Factors that may affect our results are summarized in our quarterly release and described in detail on our SEC filings. Please note that F5 has no duty to update any information presented in this call. With that, I'll turn the call over to Andy Reinland.

Andrew Reinland - Chief Financial Officer & Executive Vice President

Thank you, John. In a relatively challenging environment, F5 delivered year-over-year revenue growth and strong profitability. Revenue in Q2 grew 2.4% year-over-year to $483.7 million, within our guided range of $480 million to $490 million. Non-GAAP earnings per share were $1.68, above our guided range of $1.61 to $1.64 per share. These results exceeded our forecast driven by strength in gross margins and prudent management of expenses, as well as a decrease to our worldwide effective tax rate and the strong buyback of our common stock.

GAAP EPS of $1.11 per share was below our guidance of $1.13 to $1.16 per share due to one-time costs for a patent-related jury verdict and other costs associated with that litigation. The related impact of these one-time costs to GAAP EPS was approximately $0.08.

Product revenue of $225.4 million declined 4% sequentially and 8% year-over-year and represented 47% of total revenue. Service revenue of $258.2 million increased 1% sequentially, 13% year-over-year, and accounted for 53% of total revenue.

Revenue from the Americas accounted for 56% of total revenue during the quarter; EMEA contributed 25%; APAC, 13%; and Japan, 5%. On a year-over-year basis, the Americas were up 1%, EMEA revenue was up 8%, APAC revenue grew 1%, and Japan revenue was down 1%.

Enterprise customers represented 64% of total sales during the quarter. Service providers accounted for 21%, and government sales were 16% including 7% of total sales from U.S. federal. In Q2 we had three greater than 10% distributors: Westcon, which accounted for 18.2% of total revenue; Ingram Micro, which represented 15% of total revenue; and Avnet representing 13.3%.

Our GAAP gross margin in Q2 was 83%. Our non-GAAP gross margin was 84.6%. Including $8.9 million for patent-related jury verdict and other costs associated with that litigation, GAAP operating expenses were $286.5 million, above our guided range of $272 million to $281 million.

Non-GAAP operating expenses, which exclude these patent litigation costs, as well as stock-based compensation and amortization of purchased intangible assets, were $239.8 million. GAAP operating margin was 23.8%. Our non-GAAP operating margin was 35%. Our GAAP effective tax rate for Q2 was 34.5%. Our non-GAAP effective tax rate was 32.7%.

Turning to the balance sheet, cash flow from operations was $133.1 million. In Q2, we repurchased 2.1 million shares of our common stock at an average price of $94.62 for a total of $200 million, ending the quarter with approximately $1.1 billion in cash and investments. At its April meeting, the board approved an additional share repurchase authorization of up to $1 billion.

DSO at the end of Q2 was 50 days. Inventories were $35.2 million. Capital expenditures for the quarter were $16.5 million. Deferred revenue increased 17% year-over-year to $842.7 million. And we ended the quarter with approximately 4,325 employees, an increase of 50 from the prior quarter.

On to our fiscal Q3 outlook, as we enter into the historically stronger second half of our fiscal year, we remain focused on business execution and the delivery of our upcoming new products and features to drive the next leg of growth for F5. With this in mind, our revenue target for the third quarter of fiscal 2016 is $490 million to $500 million.

GAAP gross margin is anticipated to be in the 82.5% range, including approximately $4.5 million of stock-based compensation expense and $2.7 million in amortization of purchased intangible assets. Non-GAAP gross margin is expected to be at or around 84%.

We anticipate GAAP operating expenses in the range of $270 million to $279 million. This includes approximately $36.5 million of stock-based compensation expense and $0.8 million in amortization of purchased intangible assets.

For Q3, we are forecasting a GAAP effective tax rate of 35% and a non-GAAP effective tax rate of 33%. Our GAAP EPS target is $1.29 to $1.32 per share. Our non-GAAP EPS target is $1.77 to $1.80 per share.

We plan to increase our head count by up to 50 employees in the current quarter, and we believe our cash flow from operations will be at or around $155 million.

With that, I will turn the call over to John McAdam.

John McAdam - President, Chief Executive Officer & Director

Thanks, Andy; and good afternoon, everyone. Overall, I was pleased with F5 team's fiscal Q2 performance. We delivered year-over-year revenue growth of 2.4%, with strong profitability and operating margins in a relatively challenging business environment.

From a sales perspective, EMEA, Japan and the Asia Pacific region all delivered year-over-year sales bookings growth. Sales bookings in our America region were down year-over-year in Q2 as we experienced a drop in sales in our two strongest verticals: finance and telco. However, in spite of the shortfall in these verticals, sales from large transactions remained solid in the Americas during the quarter with year-over-year growth from sales in the $1 million-plus category.

Our services business continues to deliver strong results and excellent profitability with year-over-year revenue growth of 13%; also deferred revenue growth 17% year-over-year in the quarter, which should bode well for future business. Our Good, Better, Best pricing models continues to be a significant percentage of our bookings with year-over-year growth of 25%. As in previous quarters, customer adoption of the Best category remains very strong.

Overall, software revenue also remained strong in Q2 with more than one-third of product revenue coming from software sales driven by security module sales, GBB and software-only VE solutions. Security continues to be the growth driver of our business. We had a number of excellent wins last quarter driven by our application security modules with strong year-over-year growth in large transactions. For example, a global Fortune 25 company invested almost $1 million in the F5 APM solution to enable identity and access management for their employees into the Microsoft Office 365 environment.

Also, we won a project with a U.S. regional airline, who invested nearly $1 million in our on-premise web application firewall to help mitigate malicious and organic DDoS-oriented service interruptions.

Another example was with a telco provider with more than 20 million subscribers which made a significant investment in Silverline anti-DDoS services to thwart attacks orchestrated by an unidentified hacktivist.

We delivered solid sequential and year-over-year growth from Silverline, our cloud-based subscription DDoS and web security services. The pipeline for Silverline services continues to grow, and we continue to invest in additional head count in sales and support resources to take advantage of this growth opportunity.

We also launched an inside sales initiative in Q2, targeting the mid-range market opportunity where there's a real need for application and DDoS protection ideally suited to a subscription service model.

We also had some excellent wins in the hybrid private and public cloud environment. A large European banking customer purchased over several hundred thousand dollars of VE subscription licenses through the AWS marketplace for the deployment of a new customer engagement portal that coexists with the existing infrastructure and will ultimately support more than 10 million customers.

A large SaaS customer invested in VE license through the AWS marketplace to provision Layer 7 local traffic management capabilities on a new platform-as-a-service offering to their installed base.

Another cloud win last quarter involved a large U.S.-based entertainment content provider purchasing VE licenses through the AWS marketplace as part of their lift and shift strategy to move their customer interaction operations into the public cloud.

As far as the outlook is concerned, Andy indicated that we expect to deliver revenue in the range of $490 million to $500 million. In the context of several global macroeconomic issues we delivered strong financial results in Q2, but as we stated last quarter, we believe it is prudent to remain cautious in the short-term. We have made good progress in all our strategic and major initiatives in Q2. As I mentioned last quarter, we have no shortage of short-term business drivers, which we will introduce starting this current quarter.

Earlier this month, we introduced a new version of TMOS, version 12.1, known internally as the Cascade release. Cascade supports the new 100-gig blade for our high-end VIPRION series which I will talk about shortly. Cascade also makes huge strides to increase F5's leadership in application programmability and application deployment. Cascade introduces F5's next-generation iRules and iApp functionality, called iRulesLX and iAppsLX.

iRulesLX allows users to leverage Node.js libraries to provide new functionality addressing the needs of the DevOps market, as well as customer applications that need customization and programmability. iRulesLX is based on the LineRate technology and is fully integrated in TMOS.

iAppsLX allows for easy programming of specific use cases for application services, leveraging the broadly used web application programming language JavaScript. iAppsLX also significantly enhances the F5 orchestration and SDN product as it allows use cases to be dynamically published via BIG-IQ into the various SDN controllers such as the Cisco APIC, VMware NSX and OpenStack. This is a really unique feature which should give F5 a clear advantage with our SDN partners.

We are on track to deliver a new performance FIPS appliance and LME (15:15) based on the BIG-IP 10000 series appliances. It uses next-generation technology, enabling an eight times improvement in the SSL performance of existing solutions. This product is designed to address core requirements in both our financial services and our federal markets.

We successfully demonstrated our 100-gig blade for the high-end VIPRION series platform at Mobile World Congress last quarter. The new VIPRION 100-gig interfaces more than doubles the performance of an existing cards thereby enabling the first-ever terabit-class ADC in the market. We are seeing strong interest in the 100-gig blade from our global service providers and have already received an initial $1 million-plus order for the product. The 100-gig blade is on track for delivery in May and we would expect to see initial revenue from the 100-gig blade this quarter, current Q3, with growing momentum in Q4 and into fiscal 2017.

The new blade runs all TMOS application modules and is targeted at service provider applications including Gi firewall, Carrier-Grade NAT, and intelligent traffic steering. BIG-IQ release 5 is also on track for release this quarter and we are very encouraged by the customer reaction to the new functionality and scalability improvement that are included in the release. Release 5 includes centralized management for all security products including APM, ASM, AFM, Gi Firewall, and WebSafe anti-fraud. It also adds new device management capabilities, ADC management and application analytics.

I mentioned in last quarter's call that we plan to expand our product portfolio by adding purpose-built security products which will address new markets. The initial release will include an SSL Intercept and SSL Air Gap solution, as well as a standalone DDoS solution with new behavioral and intelligence capabilities. There have been some small changes in the delivery schedule for these two products. The initial release of the SSL Intercept and Air Gap products will now be available in early-July; and the standalone DDoS product should be available slightly earlier than expected with availability towards the end of this current quarter.

It's worth noting that we have already won large SSL Intercept projects using our existing iRules on our current ADC range of products. The initial version of the standalone SSL Intercept solution will use our existing iApp technology to allow much simpler implementation. This will then be enhanced further by using the new iAppLX (sic) [iAppsLX] (18:01) functionality in a later release.

We're also making good progress to release a 40-gig capable version of our software VE solution. Intel demonstrated our F5 VE solution in a 100-gig environment at Mobile World Congress and received a lot of interest from service providers who have the goal of driving NFV architectures in the future.

Progress on our plan to deliver a comprehensive appliance refresh is going well and we are on track to commence delivery of the new products in July and have all products available within a three-month to four-month window.

The new appliances, known internally as the Shuttle series, significantly improve performance, decrease total cost of ownership and increase our competitive leadership. However, the Shuttle series is much more than a simple product line upgrade. The Shuttle series is DevOps-friendly, encompasses a full stack of security solutions and offers specific persona-based customized solutions using our proprietary FPGA software-defined hardware functionality.

The Shuttle series will support our application modules across the entire product lineup and are designed to support and enable two-tier architectures including hybrid clouds. Our high-level goal with the Shuttle series is to bridge the gap between traditional IT, the DevOps environments and the emerging cloud architectures.

I continue to believe F5 is in a really strong position to take advantage of industry trends and customer requirements. Our absolute focus is on execution with the primary goal of delivering product revenue growth. And I believe this goal will be achieved as we deliver the new product business drivers to the market.

We have added several key executives to the F5 team last quarter to support and enhance our focus on execution. You may have seen recent press releases announcing the appointment of key sales and security executives to F5.

I'm really excited to have Pete Brant, David Helfer and Mike Convertino in the F5 team. Pete joins us as SVP for North American Sales and brings with him a fantastic track record with more than 20 years of experience in technology and security sales. David joins us as VP of Worldwide Channels and brings extensive experience in global channels and sales operations, again with a fantastic track record. Mike is F5's first Chief Information Security Officer. His first priority is the continued protection of the company's customer assets and data. Mike will also play a lead role in the development of F5's securities product roadmap and represent F5 in the IT industry and wider security community.

In conclusion, I would like to thank the entire F5 team, our partners and customers for their support last quarter. And with that, I'll hand the call over for Q&A.

Question-and-Answer Session

Operator

Thank you. And our first question is from Alex Henderson with Needham. Your line is now open.

Alex Henderson - Needham & Co. LLC

Hi.

Andrew Reinland - Chief Financial Officer & Executive Vice President

Hey, Alex.

Alex Henderson - Needham & Co. LLC

So, just a couple of very quick, detailed questions. Can you tell us what the actual ending share count was given how much you guys are buying back?

Andrew Reinland - Chief Financial Officer & Executive Vice President

Yeah. So, our fully weighted diluted share count for the end of Q2 was 67,000,804.

Alex Henderson - Needham & Co. LLC

No, that's the average. What's the actual ending?

Andrew Reinland - Chief Financial Officer & Executive Vice President

Yeah. Just give us a second...

Unknown Speaker

Give us a second, Alex, and we'll get that to you.

Alex Henderson - Needham & Co. LLC

And then the second question on the linearity in the quarter, you clearly had some angst in the broader marketplace in January and February. It seems to have gradually resolved itself over the course of the last month of the quarter and into April. Has that been your experience over the course of the quarter? Was it soft in January/February and then improved linearly over the course of the quarter? Can you give us some sense of what's happening?

John McAdam - President, Chief Executive Officer & Director

To some degree that was the case. So, obviously, January and February, we did see some angst. We started to get a little bit worried about visibility, but obviously we check linearity weekly, and it wasn't a disaster, but it wasn't probably as good as we would've liked to have been.

We did see visibility start to clean up towards the end of the quarter, which was obviously encouraging, because that was slightly different from last quarter, where I said almost the opposite.

Alex Henderson - Needham & Co. LLC

And if I could, just on that same subject, would the financial segment, because of how awful their business was in the quarter, be one area that didn't do that?

John McAdam - President, Chief Executive Officer & Director

No. No, no. We actually had some pretty strong transactions towards the end of the quarter that we expected in the financial segment. And by the way, Alex, I mentioned in my script that obviously financial and telco were down somewhat. They weren't down a significant amount; well, finance in particular wasn't down that much. Telco was actually down more.

Alex Henderson - Needham & Co. LLC

Great. Thanks.

John McAdam - President, Chief Executive Officer & Director

Okay. Thanks.

Unknown Speaker

Alex, the number you were looking for was 66,000,981.

Alex Henderson - Needham & Co. LLC

Okay. Thank you very much.

John McAdam - President, Chief Executive Officer & Director

Thank you.

Operator

Thank you. Our next question is from Rod Hall with JPMorgan. Your line is now open.

Unknown Speaker

Hi. This is RK (23:51) on behalf of Rod. Thanks for taking my question. I wanted to ask about the enterprise spending weakness that you're seeing and what's driving that. So, do you think it's all driven by just the macro weakness or, I mean, EMC today, earlier today talked about how they're seeing customers pausing spending as they look at the various different cloud architectures. Do you see some of that too?

And I was also wondering if you think that customers are pausing spending ahead of your upcoming product research? Thanks.

John McAdam - President, Chief Executive Officer & Director

Yeah. Okay. Yeah. So pretty much similar to what we said last quarter; in other words we do see macro. We don't think it's a strong spending environment in general out there, but we are also, in our opinion, we think there are delays in spending caused by customers effectively strategizing over the new cloud architectures and what applications they should take and basically planning that. So I think we're seeing some slowness because of the transformation in architecture. So that's two reasons.

I must admit that I think there's another reason. I mean, over time, we've seen some disruption, and it's been well publicized in management. And I think that's behind us now. I talked about some of the hiring that John DiLullo, in particular, has done over the last couple of quarters and (25:22) back in charge in North America, and I feel really good about that. But, the two big ones for us are really the macro combined with the fact that the cloud architectures, and you combine those two together and that makes it easy to make a delay in the spending decision.

And then in terms of the Osborne (25:43) type question that you asked about, not really. I can't say we're seeing much of that, we're watching it like a hawk especially this quarter because I did say that the big product shipments which is the Shuttle series is now destined for July, so we're feeling good about really getting a good date now that's pretty soon. And I think we're going to be okay with that, but we're watching it very, very closely.

Unknown Speaker

Thank you.

Operator

Thank you. Our next question is from Matt Robison with Wunderlich. Your line is now open.

Matt Robison - Wunderlich Securities, Inc.

Hey, thanks. So, I was hoping you could elaborate a little bit more on the TCO benefits for Shuttle series. I'm trying to get my arms around what's going to stimulate an installed base upgrade cycle.

Karl D. Triebes - Chief Technical Officer & EVP-Product Development

Yeah, I mean – hi, this is Karl. Real quick, there's a few things. One is, typically every time we release new appliances, the new generation tends to be, on average, about two times to four times faster for the equivalent price points. And so, we certainly are moving forward in that direction with these.

All of these appliances also now support FPGAs, all the way down the lineup. And so, as John mentioned in his script, we're going to be supporting these use case driven versions of these FPGAs for specific scenarios like security or other areas where you can optimize the platform depending on how you're going to use it.

So, for example, with security, if you want to block, say, IP addresses, you can do that in hardware. Or for like private cloud scenarios and data centers, you'll be able to connect things transparently through the hardware versus doing it through having to balance everything through the CPU. So, you get not only benefits from just the back-end horsepower, but also from the ability to offload a lot of functionality into the hardware and the appliance.

John McAdam - President, Chief Executive Officer & Director

And also with the performance improvement you get more modules on a single system than you would normally get. So there's a bunch of areas there, but I actually think the big one – and that's why I said it's not just a product line upgrade, because we're going to get all that good stuff, and hopefully the customers will benefit from the savings that they get. But, more importantly, SS bridge (28:01) we see as a bridge between the existing on-premise architectures and the cloud with some of the stuff that we can do that Karl mentioned on FPGAs to tunnel connectivity between private and public clouds and these products.

Matt Robison - Wunderlich Securities, Inc.

Okay. So a part of it is, when you say offload that sounds like maybe you're pulling some wallet share from some other adjacent types of products. I know you've mentioned the SSL Intercept. But, are you talking about those kind of (28:33)

Karl D. Triebes - Chief Technical Officer & EVP-Product Development

No. We're offloading it from the CPUs, so we're not having to burn CPU cycles. So, you can do anything in software, but it's a question of performance. And by offloading certain functionality into the hardware of the system, we can really heavily optimize this. And by the way, this is – if you look at Intel's approach with their acquisition of Altera, they're taking the same approach where you can allow for optimization of hardware elements as well as software elements all on the same system. So...

Matt Robison - Wunderlich Securities, Inc.

So what you're really talking about is going back to what John said about running more modules on a given appliance...

Karl D. Triebes - Chief Technical Officer & EVP-Product Development

Yeah. So, more functionality, more modules, more consolidation, more performance. The systems will also have more memory, so we can support higher concurrency limits. There's a lot of goodness with that architecture.

Matt Robison - Wunderlich Securities, Inc.

So the TCO comes down to running more modules then?

John McAdam - President, Chief Executive Officer & Director

That, plus the other things we said.

Matt Robison - Wunderlich Securities, Inc.

Okay. Thanks a lot.

John McAdam - President, Chief Executive Officer & Director

Okay. Thanks.

Operator

Thank you. Our next question is from Vijay Bhagavath with Deutsche Bank. Your line is now open.

Vijay K. Bhagavath - Deutsche Bank Securities, Inc.

Yeah. Thanks. Yeah. Hi, John and Andy. Question for you around your roadmap focus. I'd like to better understand the focus and emphasis of the roadmap. Is it on speeds and feeds like you just mentioned the 100-gig VIPRION blades or would it be in security, for example, some of the growth opportunities in security outbound firewalls end point security, threat analytics? I think where I'm coming from is I want to better understand over the next few years do you see F5 primarily as a security company, or do you see it primarily as an ADC company? Thanks.

John McAdam - President, Chief Executive Officer & Director

Now, this is an easy question. So, first of all, by a mile the focus is on more sophistication and feature sets within the software. That's obviously the way things are going and especially by a long way security being the main focus for us. So, things like behavior analysis, areas like that where you'll see enhancing all our software capability. Our goal has always been to add features to increase our addressable market especially in security and that's what you're going to see.

Speeds and feeds are great because they tend to be pretty tactical from a growth perspective and we'll take advantage of that, but over time what we're interested in is building our security portfolio that's absolutely focused on our skill set which is application security and then increasing that. And increasing it not just by functionality, but also by the way we take it to market, like, for example, the Silverline services having our own cloud-based (31:10) And then, of course, putting that software on all the public clouds as well.

Karl D. Triebes - Chief Technical Officer & EVP-Product Development

And just to add to that, just giving an example performance and functionality are critical, because we use the Gi firewall, for example. We're able to get in – one of the reasons we're able to get in there is that we can replace racks of gear with a much smaller footprint with a much higher TCO and so performance has to be there, the functionality has to be there, but those two go hand in hand.

Vijay K. Bhagavath - Deutsche Bank Securities, Inc.

Yeah. Perfect. A quick follow-on is on Europe and Asia. We have heard mixed signals from other companies that have reported. What are you seeing, John, in terms of a demand outlook in Europe and Asia? Thanks.

John McAdam - President, Chief Executive Officer & Director

Yeah. We're happy with it. I mean, I actually – it was quite specific that we actually saw year-over-year sales, bookings growth in APAC and in Japan and in EMEA. And we think we're actually doing really well there and we've got a good opportunity.

Vijay K. Bhagavath - Deutsche Bank Securities, Inc.

Thanks.

Operator

Thank you. And our next question is from Sanjiv Wadhwani with Stifel. Your line is now open.

Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc.

Thanks. Just two quick questions. John, any further granularity on what exactly happened with the telco vertical? It looks like it was down probably in the mid-teens or so.

And then second question on product revenue growth. I know you talked about that. Should we be looking at product revenue growth in July and September on a sequential basis than on a year-over-year basis? Thanks.

John McAdam - President, Chief Executive Officer & Director

On your first question, just for clarity, were you saying it was down 15% or – because it was 21% of our revenue for the quarter.

Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc.

Right, John. Maybe my calculation might be a little bit off, but telco was down, I'm thinking, in sort of the mid-teens or somewhere around there.

John McAdam - President, Chief Executive Officer & Director

Yeah. As I mentioned, telco – I mentioned the two verticals, telco and finance and I did say that telco was down more. We've seen this so many times and the really big one was, I don't even like mentioning it, but it was in 2013 in the same quarter where we saw telco slump pretty badly. There's definitely – I think it was a slow spending environment in telco last quarter. I think we've seen that from some of our peers and announcements that they've made. There also, I think, there's some slowness related to some of the decisions we're making from an NFV architecture perspective.

Having said all that, we look at the interest level on the 100-gig blade and it's very high. Now, we're not announcing it. We're not shipping it until May. We have taken fairly sizable order already, and we expect to make revenue this quarter. So, I think, to be frank, I think the biggest – the real run rate starts in Q4, but we will see additional revenue. And that, I think, will help certainly in the short-term and beginning of 2017 the telco vertical. But, apart from that, I don't think there's anything systemic. It's all about with us, typically, projects not closing or moving from one quarter to another.

Andrew Reinland - Chief Financial Officer & Executive Vice President

And then to your question on product revenue growth, I mean, obviously, we don't guide beyond the current quarter, but you do see sequential growth implied in this coming quarter and that's our absolute focus and that's why we're spending a lot of time talking about the new products coming out and the impact we think that's going to have through the rest of the year and into 2017. So, we'll see.

Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc.

Got it. Appreciate it. Thank you.

Operator

Thank you. Our next question is from Ittai Kidron with Oppenheimer Securities. Your line is now open.

Ittai Kidron - Oppenheimer & Co., Inc. (Broker)

Thanks. Couple of questions from me. First, following up on Sanjiv's question on the service provider. John, is there potential any (35:06) in front of your 100-gig introduction? And can you tell us if there's been some unusual turnover in your sales force in general and maybe in your service provider sales force more specifically?

And then, Andy, with regards to OpEx, I think, in your investor day last year, you've kind of talked about how you expect operating margins in the second half of the year to be better than the first half of the year. Clearly it's showing, but can you give us a little bit sense of a magnitude? How much of an improvement? Should we see a little bit more a flattish pattern from your R&D expenses, which have been moving up quite aggressively in the last three quarters? Does that flatten out here – how much of a lift we're getting operating margin-wise.

John McAdam - President, Chief Executive Officer & Director

Okey-dokey. I'll take the first two then. On the delay, I mean, it's always tough to tell that. There may be some proportion of delay that happened last quarter. Remember, we're spending a lot of time talking to the large customers, large service provider customers about the 100-gig. We've got a pretty good view into the potential demand both this quarter and next. As with any new product, they will try it out, which is why I was indicating that we'll probably see a stronger reception to it in Q4, because it's only going to be coming out in May, but we feel really, really positive about seeing revenues this current quarter as well.

So it's difficult to actually measure that type of question. I would probably say that, because it's going to be available this quarter, one cancels out the other. In other words, I don't think there's going to be any significant delay because of the 100-gig, just to be specific.

Regarding the turnover question, we don't really talk about that stuff much, but I will comment on it. We did see some turnover last quarter in the Americas. We're addressing that aggressively. In fact, we have addressed most of it aggressively, actually, to make sure that we don't lose any momentum because of that. But, I wouldn't go into it in any more detail than that.

Andrew Reinland - Chief Financial Officer & Executive Vice President

Yeah. And on operating margin, the messaging we put out there still holds. And if you look at our revenue guidance against the OpEx and gross margin I put out there, we are going to see some improvement in operating margin. But like we always say, we're going to watch it against the revenue and adjust accordingly. So, we're looking forward to continued improvement against revenue growth. And if we see that, we'll have it; and if not, we'll adjust accordingly.

Ittai Kidron - Oppenheimer & Co., Inc. (Broker)

Very good. Good luck, guys.

John McAdam - President, Chief Executive Officer & Director

Yeah. Thank you.

Operator

Thank you. Our next question is from Jim Suva with Citi. Your line is now open.

James Dickey Suva - Citigroup Global Markets, Inc. (Broker)

Thank you very much. It seems like in the next couple quarters you've got a lot of new product launches and things like that, which is very exciting. Don't get me wrong. Can you help us understand about what we should be thinking about for OpEx as well as margins? I think you'd mentioned you're going to be hiring this quarter about, I think you said 50 additional employees, which is good. The cost profiles or the operating expenses and associated gross margins of, kind of, the run rate what we're doing now versus these newer products, so we don't get too ahead of ourselves and monitor in how they plan out with these next couple quarters of your new product launches. Thank you.

Andrew Reinland - Chief Financial Officer & Executive Vice President

Yeah. So, specifically on gross margins, where we think we could see potential upside, we don't think the new products coming out will have a lower gross margin profile. This is really about mix and mix-to-software, and the impact that could have on the longer term to our margin. And we'll see.

As we talk about quite a bit, if we do get gross margin improvement, we like to look at how we can invest that back in the business, and our most recent obvious example is bringing Silverline to market with really not (39:13) much of an impact on our overall business model. And though we don't guide much beyond the next quarter, where you see we said 84% for our non-GAAP gross margin, we expect to see strong gross margins continue, and we'll manage it very carefully.

James Dickey Suva - Citigroup Global Markets, Inc. (Broker)

Great. Thank you very much for the details.

Operator

Thank you. Our next question is from Mark Moskowitz with Barclays. Your line is now open.

Mark Moskowitz - Barclays Capital, Inc.

Yes. Thanks. Good afternoon. Two quick questions, if I could. I just want to drill a little deeper in terms of the international strength, if you will, relative to the U.S. How much of that is related to market share gains versus just penetration of existing customers?

And then the other question we had, we've been doing some work and obviously have limits in terms of how many VARs we can speak with, but the VARs seem to feed back to us that hey, a lot of our customers don't recognize F5 as a security vendor. I was just kind of curious why you're not taking advantage of this opportunity with all these new products and maybe spend a little more from a sales evangelism perspective to get the word out that you're going to be a long-term security vendor?

John McAdam - President, Chief Executive Officer & Director

Okay. Let me take the second one first. I mean, we do – we couldn't deny that we could improve our security profile image, because we think we've already earned it, but clearly we haven't earned it from a marketing or a profile perspective, and we need to do that. So you'll see us doing a number of things. I mean, if you look at some of the hires that we're hiring, we're hiring more and more security people, and we've added significant security experts within the field to support the overall sales force. We've had it – I talked about Pete Brant with his background in security, our new CISO. So, you'll see us doing more than that.

I'm not going to say anything specific of that spend, but it's the big focus for us, because it's the future. We're also pushing ahead with the security research team as well, because we do need to get more public about that. I mean, in fact, if you looked on the script today, we probably never really mentioned some of the security wins we've had during the call we've started to do that as well. So, we do take that – we take that input very seriously.

In terms of the first question on outside of the Americas in terms of how's the growth profile, I'm not sure it's directed at market share gain and/or customer penetration. I think, first of all, typically, when we penetrate, say, the times 200 that's a good thing, because that means we do more and more business. So, we love the concept of penetrating into existing customers. There's so many applications that we can sit in front of and optimize. I don't think it's really that.

I think they've been executing well in a tough environment, obviously, but they've been executing well in those environments. We think with the changes we've been making, that John DiLullo has been making in sales in the Americas, you're going to see similar execution coming in the future as well.

Mark Moskowitz - Barclays Capital, Inc.

Thank you.

Operator

Thank you. Our next question is from Jayson Noland with Baird. Your line is now open.

Jayson A. Noland - Robert W. Baird & Co., Inc. (Broker)

Okay. Great. Thank you. John, I wanted to ask about the dedicated security products DDoS in June and SSL in July. I guess that's not a surprise since you guys have a lot of traction in those categories now, but is this just the beginning of a portfolio expansion in security?

And then, Andy, if you could talk to the sales overlay. Are these SEs working with account managers, or are you hiring dedicated account managers with security quota? Thanks.

John McAdam - President, Chief Executive Officer & Director

Yeah. Okay. On the first question, yeah, it's absolutely beginning and Karl can talk about this in a second. I would say, first of all, DDoS we feel really good about across the board, and you'll see us linking a standalone DDoS solution to a Silverline DDoS solution via signaling, which is going to be pretty unique and feel good about that. But, the reason I'm mentioning the first two is that we're hearing a lot of interest from the field on SSL Intercept and SSL Air Gap. So, yes, we will be adding more, but our main focus is going to be taking that opportunity. In terms of the types of things we're adding, the Shuttle series is obviously geared to that to that and Karl might want to comment, just in general.

Karl D. Triebes - Chief Technical Officer & EVP-Product Development

Yeah. I was going to comment. We're significantly enhancing our security portfolio. I mean, centralized management, we didn't talk about that, but with BIG-IQ 5.0 our whole security or portfolio is now managed under one central controller. We can manage multiple hundreds of devices, tens of thousands of objects, things like that. So we're really expanding that. And then with the appliances the SSL Intercept John mentioned, the same thing with the DDoS as well as Carrier-Grade Firewall and some other things that we're planning in the future. We're significantly enhancing the capabilities at DDoS solution in addition to that, doing things like behavioral DDoS, being able to fingerprint, identify bad actors.

We can leverage that for threat intelligence speeds, we have security analytics that we're building, and that'll be coming out as part of the solution. We've been significantly enhancing our identity and access management solution, which is our APM platform. We're adding some major new features in the next six months to that to enhance its federation and single sign-in capabilities. So there's just a lot going on on that portfolio that we just don't have time to talk about here at this venue. But there's a tremendous amount of focus from the teams on that.

Jayson A. Noland - Robert W. Baird & Co., Inc. (Broker)

Andy, the cost of the sales overlay? Like how expansive is the head count addition?

John DiLullo - Executive Vice President of Worldwide Sales

This is John DiLullo. A lot of the investments that we've made in the awareness and training and making our sales team literate has been by investing in the team that we have onboard now. Over the past 18 months, we've also invested in a specialist organization that does sales and technical design, and that's the team we're running with at this point.

Jayson A. Noland - Robert W. Baird & Co., Inc. (Broker)

Thank you.

John Eldridge - Director, Investor Relations

Hi. This is John Eldridge. I just want to say we'll take two more questions, and then we're going to wrap up this call.

Operator

Okay. Thank you. Our next question is from Jess Lubert with Wells Fargo Securities. Your line is now open.

Jess Lubert - Wells Fargo Securities LLC

Hi, guys. Two questions. First, with respect to the outlook and some of the macro uncertainty you referenced, can you comment to what extent you've done anything different to be incrementally conservative in terms of developing your Q3 forecast, relative to what we've seen over the last few quarters?

And then for Andy, on the new buyback authorization, I was hoping to understand how aggressively you plan to be, and perhaps you can touch upon how you're thinking about M&A, and to what extent we should be expecting some activity during the second half of the year, as you look to bolster some of your security capabilities. Thanks.

John McAdam - President, Chief Executive Officer & Director

On the first question, I mean obviously, we're trying to be appropriately conservative, and I think we're managing that. Probably I'm going to take one thing that we're very aware of when we're looking at the forecast at the moment is the fact we've been through product transition, both good and bad. I mean 100-gig, we can see some upside, and we need to be careful about any (46:58) so we're taking a conservative view in that.

That's the main areas. And then, the real stuff, which is just crossing the Is and – sorry, dotting the Is and crossing the Ts in terms of the core business looking at forecast, making sure we do face-to-face QVRs, that type of thing. Excuse me.

Andrew Reinland - Chief Financial Officer & Executive Vice President

And then, on the buyback authorization, really that's the board teeing it up. We'll continue with our routine of every board meeting reviewing it. I think you've seen over the last couple of quarters it's actually gotten a bit more aggressive, just relative to share price being down and us setting up a 10b5-1 that has trigger points. Do I think we're going to get more aggressive? We'll have to see on that. That's a board decision, but we like the cadence that we're at right now.

As far as M&A goes, we continue to look, I would characterize it, pretty aggressively in the areas of security and telco for opportunities that we think fit, but we wouldn't comment much more than that.

Jess Lubert - Wells Fargo Securities LLC

Okay. Could you maybe just comment on deal size that you'd be looking at? Should we be expecting mostly smaller deals or would you be willing to go a little bit further out on the risk spectrum?

Andrew Reinland - Chief Financial Officer & Executive Vice President

Yeah, I think last quarter, we talked about widening the lens, which I think implies that we would look at bigger deals relative to maybe what you've seen us do. But again, it's going to be something that we look at very critically, because we understand the risk of that as well and we're going to look for those opportunities that are the right fit, both strategically and culturally that we think can really drive the company forward. So I'm very focused on that outcome.

Jess Lubert - Wells Fargo Securities LLC

Thanks, guys.

John McAdam - President, Chief Executive Officer & Director

Thank you.

John Eldridge - Director, Investor Relations

Hello. Just one more question.

Operator

Yes. Our last question is from Paul Silverstein with Cowen & Company. Your line is now open.

Paul Silverstein - Cowen & Co. LLC

Awesome. I want to thank you for calling me last, so I can ask multiple questions.

John McAdam - President, Chief Executive Officer & Director

(49:09)

Paul Silverstein - Cowen & Co. LLC

On a serious note, John, Andy, can you – couple of things. One, can you offer us any color on the cloud wins? Obviously, there's been a lot of concern among the investment community about your position relative to the cloud, Amazon, in particular, but the cloud in general. You referenced – I believe you referenced two wins in your prepared remarks, any additional color? And around that, I recognize you've been rejiggering your portfolio to optimize your cloud offerings to streamline in to get the right price points. Can you update us on where you are, how much more you need to do to get to where you want and need to be?

And then a quick question for Andy. Andy, historically, in virtual editions, I think you referenced the fact that ESPs, you used to say they were 80% of the price point on hardware. I think more recently, you've referenced them as being comparable, but I think you've always said the net income impact was a wash. I'm hoping you could update us.

And one final question if I may; I know there are a number here. But John, on the linearity issue and your comments about enterprise demand, we had Ixia recently note that there was a – they saw a meaningful downtick in the month or March from a number of comm equipment suppliers. They didn't name them, obviously, but – and then in your comments, if I understood you correctly, the quarter started off slow coming out of last quarter, in January and February, and there was a pickup in March. And I'm just wondering if you could shed any more light in terms of the pattern as it speaks to forward business.

John McAdam - President, Chief Executive Officer & Director

Yeah. On the linearity, there wasn't a massive change from the norm. But what we did see about that and I commented on was that we felt better about the visibility in March. In other words, by visibility what I'm talking about is we look at – we're looking at the pipeline and mainly the forecasted deals for that quarter and the visibility of that improved quite radically over the previous two quarters, we felt.

That's a combination, probably of macro, but also of good sales management, to make sure that we know what's going on, and that's important to us. So I wouldn't put too much on the linearity thing, because it wasn't widely different from what we'd expect. It was a little bit soft in January/February, and we were a bit worried about the visibility. In other words, we felt we'd do a lot better and we didn't. We thought we'd do a lot better and we didn't, but we came to March and we felt that visibility was excellent.

So that's – I'm trying to think – yeah, on the AWS and the cloud and that question, I mean I realize there's a lot of concern and we discussed this stuff a lot internally. But when we look at the installed base and the customers and the opportunities, we see a lot with things like our WAF product, our APM product. I actually gave three examples, in fact, of that type of thing. So there are definitely opportunities there as well.

But we've seen new business opportunities, where fairly big companies where we had no presence and we managed to get into that company via AWS marketplace, interestingly enough. And obviously, we feel good about the whole hybrid side of things, especially we're going to be more and more focused on orchestration and areas like that.

Having said all that, I do still think that it's been causing delay in spending overall. We also see some partnership opportunities with companies like Microsoft and Amazon on AWS, in terms of working with them on enterprise customers. And we had one very good example of that, that I mentioned, the banking company. Well, that was an example of a partnership.

Yeah. So I think it's early days. I mean it's not that we – we don't look at the pipeline right now and say, oh, my God, this is shrinking because of Amazon. We don't see that or because of the public cloud. There's no doubt in my mind, we probably don't get some business we would've got before, of a start-up company that was slated to the public cloud, and maybe just instead of buying equipment, just rent some software. That software could well be ours, but it's not critical yet. The major concern it gives us right now is, is it causing delays and then, from an opportunity perspective, how can we maximize our product on those public clouds and by partnering with the cloud vendors?

Andrew Reinland - Chief Financial Officer & Executive Vice President

And then, Paul, you were asking about the virtual editions on the pricing. And essentially, at our entry-level hardware systems, you do see parity on the gross margin dollar still. So it's not quite the same price-wise, but it's equivalent on the gross margin dollars.

And we're still seeing that the deal sizes aren't necessarily smaller, because usually, when they're buying virtual editions, they're deploying them on a more horizontal type of architecture, and so, they need more versions of it. So we're still in that kind of position.

Some of the things I'd highlight though was we're looking at new licensing models, specifically for the cloud. So bring your own license, where you can take the VE and move it as you want to. Enterprise license agreements, if they want a license in large scale, we'll do an enterprise license agreement. And I think where we're coming out with a 40 gig VE in an NFV environment, you may see that as well, where we do a lot of larger enterprise-type license agreements, and then, we'll see how that works out at discounting.

And then, we do offer, on a utility basis, on AWS, the ability to pull out your credit card and license our virtual editions. So we'll continue to be looking at those business models, to evolve them to the needs of our customers.

Paul Silverstein - Cowen & Co. LLC

Andy, do you have a number for what virtual edition was as a percentage of revenue?

Andrew Reinland - Chief Financial Officer & Executive Vice President

John, in his comments, said overall software is more of a third of our sales, but we don't get much more detail than that.

Paul Silverstein - Cowen & Co. LLC

Thanks, guys. Appreciate it.

John McAdam - President, Chief Executive Officer & Director

Okay, thank you.

John Eldridge - Director, Investor Relations

Okay. Thank you, Sam, and thank you, all for joining us for this call. We look forward to seeing many of you at some of the investor events we'll be attending this quarter.

Operator

Thank you, speakers. And this does conclude today's conference. Thank you all for joining. All parties may disconnect at this time.

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