Citrix Systems' (CTXS) CEO Kirill Tatarinov on Q3 2016 Results - Earnings Call Transcript

| About: Citrix Systems, (CTXS)

Citrix Systems, Inc. (NASDAQ:CTXS)

Q3 2016 Earnings Conference Call

October 19, 2016, 16:45 ET


Kirill Tatarinov - President & CEO

Eduardo Fleites - VP, IR

David Henshall - COO & CFO


Raimo Lenschow - Barclays

Walter Pritchard - Citigroup

Kash Rangan - Bank of America Merrill Lynch

Karl Keirstead - Deutsche Bank Securities

Steve Ashley - Robert W. Baird

Heather Bellini - Goldman Sachs

Gregg Moskowitz - Cowen & Co.

Abhey Lamba - Mizuho

Kirk Materne - Evercore Partners

Michael Turits - Raymond James

Ed Maguire - Credit Agricole (CLSA)

Brad Reback - Stifel Nicolaus

John DiFucci - Jefferies

Keith Weiss - Morgan Stanley


Good afternoon. My name is Shannon and I will be your conference operator today. At this time I'd like to welcome everyone to the Citrix Third Quarter 2016 Earnings Call. [Operator Instructions]. It is now my pleasure to turn the conference over to Mr. Eduardo Fleites, Vice President of Investor Relations. Mr. Fleites, you may begin your conference.

Eduardo Fleites

Thank you, Shannon. Good afternoon, everyone and thank you for joining us for today's third quarter 2016 earnings presentation. Participating on the call will be Kirill Tatarinov, President and Chief Executive Officer and David Henschel, Chief Operating Officer and Chief Financial Officer. This call is being webcast on Citrix Systems investor relations website.

The webcast will be posted immediately following the call. Before we begin, I want to state that we have posted product specification and historical revenue trends related to our product groupings to our investor relations website. I'd like to remind you that today's conversation will contain forward-looking statements made under the Safe Harbor provision of the U.S. Securities Law.

These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Obviously, these risks could cause actual results to differ to those anticipated. Additional information concerning these and other factors is highlighted in today's press release and in the Company's filings with the SEC. Copies are available from the SEC or on the Company's investor relations website.

Furthermore, we will discuss various non-GAAP financial measures as defined by SEC's Reg G. A reconciliation of the differences between GAAP and non-GAAP financial measures discussed on today's call can be found at the end of today's press release and on the investor relations page of our website. Now I'd like to turn it over to David Henschel, our COO and CFO. David?

David Henshall

Thanks, Eduardo and welcome to everyone joining us today. We continue to show great results and overall execution from the operational initiatives that have been driving profitability to the strength in product portfolio been driving top line growth. We're focusing all of our energy on the core strategy of securely delivering apps and data, really setting the company up for sustainable profitable growth as we look forward. As you can see from the release, total revenue was up 3% year-on-year in Q3. Adjusted operating margin expanded to over 30%. Adjusted EPS was $1.32 per share, up 27% year on year and we generated nearly $290 million in cash flow from ops.

In total, we closed 49 $1 million-plus transactions with particular strength in cloud, healthcare, technology and government verticals. There was also good balance across portfolio with more than half of these deals coming from Workspace Services with the balance coming from Networking. From a geographic perspective, when you exclude the GoTo businesses, revenue from the Americas was up 8%, APJ was flat and the EMEA market declined about 4%. This performance is pretty consistent with the first half of the year. The Americas GEO continues to drive significant growth across all product categories, while the other regions are seeing improving execution in many of our primary markets. Related to this, in Q3 we announced a leadership change in the APJ region and pending change in the UK and these things will help accelerate field restructuring into 2017.

Next, I want to talk about Q3 results within our three primary businesses. Within Workspace Service business which includes Virtualization and Mobility, grew 5% total to $414 million, including a 5% year-on-year increase in product license revenue. This growth rate has been really moving up over the last six quarters and is a direct result of the focused strategy we adopted last year.

As we've discussed a few times, there's a number of very specific initiatives that we're driving to accelerate growth in this area through much faster innovation, more verticalized solutions, integration of our unique assets across the portfolio and the reinvigoration of our channel partnership. A couple of other dynamics are worth noting. That includes the license revenue in the Americas GEO with -- across all of Workspace Services actually accelerated last quarter.

In Q3 this was up 18% year-on-year and this is after already posting 16% license growth through the first half of the year. Much of this has been coming from mid, large enterprise customers, often in verticals where security and compliance our major concerns. Additionally, we continue to grow our Cloud Service Provider subscriptions where our partners are primarily utilizing XenApp to deliver cloud-based offerings their customers. Overall, the Citrix Service Provider revenue grew about 30% to now have an ARR of over $75 million. Next, looking at Delivery Networking, total revenue increased 1% in the quarter to $191 million. The largest part of this overall business, NetScaler ADC, posted license revenue growth of 5% against a strong Q3 a year ago.

But impacting the results in the rest of the EU were the comps from the ByteMobile and Cloud platform products that are part of the restructuring at the start of this year. Staying on NetScaler for a minute, I will remind everybody that the business is essentially made up of three segments. Cloud Infrastructure and e-Commerce, Citrix solution sales and enterprise ADC. So within the quarter, demand from cloud and e-commerce continued to be really strong consistent with what we have seen over the last five quarters.

This segment which is made up of roughly 200 different customers in the quarter, contributed about 40% of NetScaler product sales. Solution Attach segment represented 15% of the mix with a number of app and mobile opportunities that included networking as part of an overall Citrix solution was up modestly from a year ago. And then Enterprise ADC was the remaining 45% of mix. All in, we sold over 1,600 networking customers during the period with a third of those being net new to Citrix. And finally, our SaaS delivered revenue was up 9% to $207 million in the quarter.

The contribution from the GoTo business was $173 million. And as far as the merger between GoTo and LogMeIn, we received U.S. antitrust approval in September and continue to expect this to close in the Q1 2017 timeframe. When you look at just the cloud-based services that are part of core Citrix, we delivered $35 million in total revenue, growing 28% in the quarter.

The bulk of this is coming from ShareFile, our secure data platform, with the other new offerings addressing workspaces and service needs for our customers. So clearly, we continue to see a shift in the way products are being consumed by customers, evolving slowly towards a more ratable model.

So when you include revenue that is being generated from the Citrix Service Provider Program, plus our own cloud-based services and the annual term license, the aggregate ARR is now over $225 million, growing very rapidly. So turning to operations, we have driven a lot of efficiencies in the Company over the past six quarters and continue to do so in Q3. The actions across the business were designed to generate permanent expense reductions while reallocating investments to those areas that will drive profitable growth in the future.

In Q3 adjusted operating margin was over 30%. This is up more than 400 basis points from last year. We're clearly operating well ahead of our stated goal of reaching 30% full-year margins in 2017. The focus on leverage has also helped increase our cash flow profile for the Company. Q3 cash flow from operations was a record $288 million and over the trailing 12 months we have generated a total of $1.14 billion in cash from ops and this is up 21%. As you start to model FY17, I want to point out that historically about 80% to 90% of cash flow from operations can be attributed to core Citrix business with the remainder coming from GoTo. Exiting Q3 we had nearly $2.5 billion in cash investments on the balance sheet which is up sharply from last quarter.

Over the last several years our stated target has been to utilize half of free cash flow for capital return, a level which, frankly, we have regularly exceeded. As you know, this program has been on hold due to the pending separation of the GoTo business. So once that's completed, we intend to restart our programmatic capital return and we'll talk definitively about those plans once the transaction is closed.

Before I wrap up, let me talk about our current outlook and expectations for the remainder of the year. Our growth strategy and operational programs are clearly working. We're happy with the results and we're confident in our plans for the balance of the year and looking into 2017.

At the same time, we're going to continue our conservative outlook given the pending GoTo merger with LogMeIn and the significant revenue upside we posted in Q4 of last year. That said, we're increasing our assumptions for Q4 and the full year. So for 2016, we now expect consolidated revenue between $3.4 billion and $3.41 billion and adjusted EPS of $5.18 to $5.20 a share.

This represents revenue for core Citrix to be in a range of $2.71 billion to $2.72 billion or roughly 3.5 -- or excuse me, 2.5% to 3.5% growth when you exclude the GoTo business. With respect to 2017, we're just finishing up our planning cycle which is very normal for this point in Q4. At this stage we still expect the GoTo merger to be completed in Q1 2017 so we're completely focused on the ongoing business of core Citrix.

We're feeling good about the continued improvement in results, the new product cycles and the early returns from Citrix Cloud. We're also making a go-to-market capacity investment that should drive additional growth next year, particularly in the second half of 2017.

Therefore, we're currently modeling 2017 full-year revenue growth of 3% to 4% for core Citrix and adjusted operating margins of 32% to 33%. So now I'd like to turn it over to Kirill to give further color on the quarter and our focus areas looking forward. Kirill?

Kirill Tatarinov

Thank you, David and hello and welcome, everyone. I am obviously very pleased with our results, clearly demonstrating how our new focus is resonating in the marketplace. We have seen growth in all of our core areas of business, most importantly, in our Workspace Services business, showing growth for the second consecutive quarter. Our efforts in accelerating product innovation and improving operational processes are working. And the progress on cultural transformation that defines us as a company will continue to power us forward.

We're seeing improved stability in our workforce and incredibly strong employee engagement as evidenced by very strong results and participation in our recent global employee survey. Specific to our field organization, through these improvements we now have approximately 100 more quota-carrying reps since our restructuring about a year ago. Our Americas sales team continues to fire on all cylinders with consistently strong execution quarter-after quarter. And with the leadership changes we have implemented in APJ and more change of upcoming in EMEA, we see great opportunity to replicate what is working so strongly in the Americas.

Our vision is clear, our strategy is crisp and our execution has improved dramatically. We now have had five straight quarters of continuous operating improvement. A few additional comments on our solution areas, there's a big story this quarter, of course, Workspace Services or our Xen family. It's exciting to see this core part of our business delivering 5% year-over-year increase in the license revenue. I'm encouraged by sales energy and tremendous product innovation in this area. After two quarters of solid growth, this is clearly not a fluke or just blip on the radar. This is an exciting change deliberately driven by the strongest, highly differentiated products and much improved competitive edge.

Additionally, in September and we delivered XenApp's XenDesktop 7.11, a major release featuring day one support for Windows Server 2016, management innovations and user experience enhancements. We also acquired more NorthScale, greatly complementary technology that adds extra capabilities in the user environment management adds has very smart workspace performance organization techniques unmatched in the industry. We saw more than 650 competitive wins in the virtual clients computing this quarter and our win rates have been consistently improving.

Specifically, one of the nation's largest grocery retail and supply chain services companies chose XenDesktop for VGI delivery to support the retail operations, thanks to our partnership with Microsoft. And another major win against the top competitor in the space, one of the world's largest insurance providers chose to leverage XenDesktop to enable the efficient upgrade to Windows 10 on more than 20,000 desktops, also driven by our unique support for Skype for business. We continue to see more customers choosing our entire portfolio due to stronger than ever product integration. For example, in a dual competitive win, a top clinical teaching hospital in the Netherlands is rethinking their workspace services end-to-end and chose Citrix Workspace's suite against both the virtualization competitor and the networking competitor so they can implement a full, coherent solution for hospital workplace innovation.

Moving onto Network Delivery business, as David mentioned, we saw good growth in the core ADC area with a 5% year-over-year increase from the already strong Q3 in 2015. On the product innovation front, we released a major update to NetScaler SD-WAN. We continue to be very encouraged by growth in that area. This update featured more advanced routing, simple deployment and unrivaled security capabilities. We also released NetScaler support for the fixed standard, a testament to our commitment to security and the U.S. Federal Government.

And we released NetScaler CPX, a free developer version of NetScaler in a container that allows for rapid deployment methodologies such as DevOps. It is a clear indicator for our team's focus on new technologies and increased innovation. We saw more than 500 competitive wins in the network delivery space globally, including a major African mobile communications company, a major international electronics company and a global technology company. All of which are using NetScaler to ensure high network availability, resilience and security in their services. On to data delivery. As with previous quarters, ShareFile continued to prove itself is a growing force in the enterprise file sync and share market, growing 25% year-over-year. We continued to drive rapid product innovation and expand ShareFile functionality in target industries, adding more workflows and cloud connectors.

We're starting to see increased traction of ShareFile outside of the United States where it is still the strongest and in the larger enterprise segment. Specifically, Daimler AG, one of the largest and well known producers of the premium cars and manufacturers of commercial vehicles, chose Citrix ShareFile to improve large file exchange across their organization and it will help them reduce storage costs and support business departments when dealing with big amounts of data.

On to the industry trends. Cybersecurity, bring your own device phenomenon, cloud adoption and Microsoft refresh cycle all served as catalysts to our business in Q3. We saw strong demand for our solutions to support organizations initiatives to secure their data applications and networks. This is particularly evident in highly regulated industries including financial services and healthcare which had more than a dozen large deals this quarter, as David mentioned. We also had several defense ministries and government agencies around the world choosing Citrix to address security concerns. With cybersecurity being the number one concern for enterprises of all sizes and governments around the world, it is becoming increasingly evident that Citrix solutions are indeed one of the strongest defenses against potential end point device and perimeter attacks.

Moving on to our progress in the cloud, this was a tremendous quarter in our cloud transformation. While it's still in early progress, the momentum is building with wins coming from businesses of all sizes. Highlighting just a few examples. Hilti, a well-known provider of worldwide leading edge technology for international construction professionals has partnered with us to drive their cloud transformation and enable the bring-your-own device policy for employees through Citrix Cloud. Columbia University and another major Ivy League school both chose Citrix Cloud to assist in their transition and reduce infrastructure costs and IT support needs. Citrix Cloud overall is really starting to shine.

A couple of remarks on our partnerships, this quarter we saw major step forward in our stronger than ever relationship with Microsoft. As you may recall, earlier this year we had announced an elevated and more strategic partnership with Microsoft and now I am happy to report that it is starting to bear fruit. We're seeing good alignment of our teams in the field bringing those joint wins I previously mentioned. Also in August, Microsoft announced that they were transitioning out of Azure RemoteApp and Citrix XenApp was designated as the destination for Azure RemoteApp customers. We're creating a clear migration path for Azure RemoteApp customers that want to use all of XenApp capabilities.

This announcement served as a continued vote of confidence that Citrix is clearly the right partner for future success to deliver more workloads than ever and more adoption of Windows 10 and Office 365. As to our broader partner channel, the momentum is continuing to grow. And while we have nearly 50 $1 million-plus deals in Q3, the ShareFile sales coming from the mid-market is increasing. Clear signal that our strategy to expand in mid market is working and that our partner channel is more vibrant than ever. Just last week we hosted our top partners in the Americas to give us tremendous feedback on our mutual progress. And last, but certainly not least, last month we had our annual industry analyst event where we had the opportunity to share our vision, strategy and core messaging. The feedback was remarkable.

I previously shared the confidence I heard from our customers and partners and now hearing such positive reinforcement on our direction and focus from industry analysts was truly encouraging. Our strategy and overall positioning was very well received, proving to me that we're on the right path. As I mentioned, with highly differentiated products we have stepped up our competitive edge and it is paying off. We're taking share in all our core areas of business.

Overall, I feel very enthusiastic about the business and look forward to closing out the year strong and starting 2017 with Citrix been better and stronger than ever. Thank you. And we look forward to your questions.

Question-and-Answer Session


[Operator Instructions]. Your first question comes from the line of Raimo Lenschow. Your line is open. Please go ahead.

Raimo Lenschow

Kirill question for you, the workspace growth rate of 5% was the best we've seen since I am looking back here at Q1, 2014. You mentioned some of the strength already. How confident are you that we're -- could you get a little bit deeper into what drove that growth and how confident are you that kind of that number that you can deliver in the future as well. Thank you.

Kirill Tatarinov

Thanks for the question. And obviously we're incredibly excited with the continued strength in this core part of our business. This is the second quarter and a 5% growth in license is truly remarkable. As I mentioned, it is driven by tremendous strength in our products. We just simply never had such a strong technology and the team has done a remarkable job innovating this. 7.9 release coming out at about Synergy Conference in May was very strong and is driving tremendous adoption and we have just made it even stronger with 7.11 release and with a small tuck in acquisition of Norskale.

I think it's also fair to say that Virtual Client Computing in many cases is viewed as sort of one of the core parts in cybersecurity efforts that everybody is driving and we're seeing it from regulated industries. We're seeing it from the governments, we certainly see that trend driving the business forward. And I expect that wanted to continue to and wanted to accelerator and last but not least, we're in the midst of very significant refresh cycle in Microsoft environments driven by Windows 10 adoption and recent introduction of Windows Server 2016. And I think also coupled with Office 365 and Broad adoption and unique support that we have for Skype for Business that will continue to be very significant growth catalyst.

So very encouraged by what we saw in Q3 and certainly feel very enthusiastic and bullish about future prospects in this core part of our business.


Your next question comes from the line of Walter Pritchard. Your line is open. Please go ahead.

Walter Pritchard

Kirill we've heard you talk a lot about security on the call and I guess I think security has been part of your value proposition for a long time. Is there something that's changing in that regard either from features that you put in the new release of the product or something you're seeing in the market that’s different than what you'd had in the past?

Kirill Tatarinov

I think there are a lot of things that's happening in the market and I think that overall awareness of cybersecurity is escalating quite dramatically. Even in the last Presidential debate we heard about cybersecurity, I think it's for the first time in history and I think it certainly served as a call to action too many [ph] and continuous escalation that we see from attackers being [indiscernible] a few years ago to organized crime to now real governments and cyber terrorists. This is certainly a major threat that everybody is feeling and everybody is experiencing and people are starting to see virtual client computing our core business is one of the major defenses and many people realize that essentially virtualizing their device may be one of the only ways they can truly secure the data and secure the device.

So certainly secular trend is helping. From the product perspective, we definitely continue to amp it up across the portfolio. With NetScaler capabilities that were released in June with updates to the entire NetScaler portfolio and NetScaler gateway serving as essentially conditional access with multiple factors indication that many customers are starting to deploy with information rights management being introduced into ShareFile and with continuous improvement in our core business in apps and desktop certainly from the product point of view we’ve continued to drive improvements.

But I would say last but not least is the overall awareness that we've been driving in the marketplace and I think as I shared with you when I first joined nine months ago, even when I was doing my due diligence on Citrix a year ago, what I discovered was that there is a whole lot more to Citrix than the world knows about and in the last six months most importantly starting with the synergy in many, we have deliberately driven awareness to make sure that the world actually understands what we stand for and what we have to offer and the world actually understands that improving cybersecurity defenses is the most significant outcome that our customer gets from deploying Citrix solutions. So all combined, that’s what we're seeing and that's why we amplify this and that's why it's going to be so important on a go forward basis.


Your next question comes from the line of Kash Rangan. Your line is open. Please go ahead.

Kash Rangan

Is it linked to Microsoft Windows 10 and Server 2016, Kirill, curious to get your thoughts on how this opens up new opportunities for Citrix relative to the other OS releases we've had and certainly there's been cycles of desktop virtualization option in the past, I'm curious what are the new opportunities that open up for you in this cycle and also if you can just mention very briefly what is that you are specifically implementing in EMEA that we should expect better results from in 2017? Thank you very much.

Kirill Tatarinov

I think Microsoft refresh cycle it would be fair to say that all of us expected Windows 10 adoption in the enterprise to go faster and I think most people took a bit of a pause and took a bit more time to do proof of concepts that [indiscernible] taking place into the spring, and now we're seeing adoption and now we're seeing broad adoption in enterprise and also that's what our friends at Microsoft are sharing with us.

And as in the past major Microsoft refresh cycles, Citrix gets to benefit. As I mentioned, some major, major clients are deploying Windows 10 through VDI mechanisms and that's tremendously helpful. We’re now in the final phases to implement Windows 10 VDI on Azure which is coming in just next short few months and that will serve as additional catalyst, but certainly our partnership with Microsoft and overall rate of adoption of Windows 10 is strong and it's accelerating and we're really excited about it.

On Windows Server 2016 this is the best server release ever that Microsoft had and we're seeing good momentum and read analyst reports about Windows Server adoption sort of obviously in addition to all of the rapid move to deployed into Azure. Today majority of Windows Server runs on Windows Server 2008 so their major refresh cycle is coming and we believe that Windows Server 2016 will be right there and we will be right there with it since we have supported it from day one when it was released.

Kash Rangan

And the EMEA steps, if you don't mind. Thank you.

Kirill Tatarinov

On EMEA, I think it's a transformation on leadership where in the final phases of addressing a couple of open positions in Northern Europe in particular and we look forward to reporting on sort of upcoming leadership changes in that area and articulating strong results. I will say that just like in many other companies a lot of profile they are obvious microeconomic factors that I believe impacted our performance in that region.

I did have an opportunity to spend time in EMEA region past summer and had a chance to get introduced to the team and see where we're making strong progress that served us reassurance that in Central and Eastern Europe and in Germany we have strong leadership team and we have great execution and we know precisely what needs to do, we have the model that's working very well in the Americas. We’re going to replicate it in EMEA and I think it represents good upside in my view.


Your next question comes from the line of Karl Keirstead. Your line is open. Please go ahead.

Karl Keirstead

I’ve got a couple for Dave, I will ask one at a time. David, on the margins up, I will call it 400 basis points year-over-year, you set your our core operating margin guide for 2017 higher than the prior guidance of 30%, so all good. I guess I'm asking how long this party can last type of question and may be the way I will phrase it is, how close we're to the point where perhaps driving growth acceleration becomes a little bit more important than showing margin upside. Thanks David.

David Henshall

I say that at the beginning of the year we were talking a lot about restructuring and certain initiatives and we have transformed that over the last couple of quarters just into the way we run the business. We've got an ongoing focus on efficiencies in just getting better at everything we do and that will translate into two ways. One is the margin you see and then two is our ability to reinvest a lot of the savings if you will back into things that will drive growth. I would say that the team is much more focused on driving growth into the future than margins because we're building that muscle just kind of in the ongoing operations of the company.

As you mentioned, we’re up better part of 800 basis points over two years. There is still a number of specific projects in flight those that have longer tail whether it's real estate related or procurement or those types of things that will continue to generate permanent savings. As we saw on our preliminary guidance for 2017 we do think that there's a lot more opportunity to run the business at even more efficient levels than we're today, we're going to keep driving those, but I also think that you will hear us talk much more about growth going forward because we're building a business around profitable growth and that's the focus of the execution.

Karl Keirstead

And then maybe as my follow up, a balance sheet question, David your long term deferred revenue growth has been really solid last four quarters up 15%, 20% but in the third quarter just reported up 12% not a big deal but is there any story there that you can pass on to us around the long term DR [indiscernible]?

David Henshall

No. No story. I think if you look at our deferred revenue profile over the last many years you tend to see Q2 and Q4 the quarters where it goes up, Q1 and Q3 it just kind of dips down it's just the cycle of the business. So I would expect that to pop pretty heavily in Q4 this year.


Your next question comes from the line of Steve Ashley. Your line is open. Please go ahead.

Steve Ashley

Dave I was going to follow up on the initial 2017 guidance realize it's -- I'm not going to call it preliminary but that is high level at this point. Do you have any color around what kind of expectations we might have for the product sectors of Workspace Services or Delivery Networking, how we might think about their growth rate in 2017? Thanks.

David Henshall

Yes Steve, we're not going to guide at that level right now, but just to talk about that a little bit more. Everything that Kirill mentioned earlier in terms of the momentum around the Xen family business that's just pure execution and the other thing we've talked about is that there is an ongoing subscription component to that, the Citrix service provider business that I mentioned which is largely Xen family that’s up to about $75 million ARR growing at 30%.

So we're addressing both more and more incremental efficiencies at the higher end of the market and also programs like CSP which are just net new largely targeting SMB in some mid-market. So it's coming from a number of different factors and we feel like that momentum can continue. In terms of networking, there is really three big segments of that business as everyone knows it's primarily around the secular trend towards cloud and e-commerce and SaaS providers, we're doing extremely well in that business and we will continue to expand the base.

The attach motion for today represent about 15% of the mix, that's been a function of what's been going on in the last five years around Workspace Services. So as that business accelerates, we will just have many more opportunities to go unattach and then turned around the part that we just term core enterprise ADC, that’s probably our single biggest capacity add from a go to market standpoint in 2017.

We've been ramping that up really last quarter and we will finish that up in Q4 timeframe, but at the end of next year we will probably have a 20% increase in networking capacity across the Board. So while it's largely a second half story, it's an area that we believe we can continue this trend of taking share each and every year. We just need to be involved in more places where our customers are. So that's just a little contextual flavor around the business, but in terms of overall guidance, just to reiterate, this year the core business is doing about 2.5%, 3% growth, our premium guidance for next year is to accelerate that to 3% to 4% and we think we can do that at a higher margin structure.


Your next question comes from the line of Heather Bellini. Your line is open. Please go ahead.

Heather Bellini

I was just wondering if you could share with us how you're thinking about the opportunity changing for VDI. We've heard a lot about the price points due to hyper converged coming down over the last year or so enough and an uptick in demand as a result, I wanted to see how you see this trend reevolving if at all. Thanks.

Kirill Tatarinov

We certainly see renewed energy from our customers and from our partners in the overall virtual cloud computing and that involves VDI, that involves XenApp and virtual app and frankly it also includes Xen mobile and it's sort of complete end to end end-user computing and device management. VDI is one segment that will be largely influenced by the refresh cycle of Windows 10 and we certainly see significant momentum and excitement building up there and we feel that we're going to be a strong beneficiaries of that trend. We do have strong partnerships with hyper converged appliance providers in particular Nutanix last quarter and now it's increased partnership with XenServer, they are putting XenServer in their appliances now and they are working with us on the entire VDI staff and on their appliance. It is primarily designed to serve mid-market which is obviously going to deploy to our strategy of continued expansion and mid-market customers and I view that as another net positive catalyst going forward.

Heather Bellini

And just to follow up, thank you for that, any change in the competitive dynamics there?

Kirill Tatarinov

Well I think the change is very profound and the change is very visible. We see it everywhere we go. With the strongest highly differentiated product and with dramatically improved competitive position in the marketplace, we see increased win rates. We see increased win rates in virtual client computing, we see increased win rates in networking and that served as a very tremendous positive catalyst for the way our people feel and the way our partners feel and frankly the way the industry feels about it and I think it's really the case where success breeds more success.


Your next question comes from the line of Gregg Moskowitz. Your line is open. Please go ahead.

Gregg Moskowitz

David, your gross margin improved for the first time in a few quarters and all else equal, you'll get an additional lift next year without GoTo but as part of your guidance how are you thinking about overall gross margins in 2017?

David Henshall

Yes. We haven't actually guided to gross margin yet for 2017. I think coming out of this quarter we will fill out the P&L, give you a little more granularity but just it's the same basic trends in Q3 that we've seen over the last couple of years. We’ve talked for several years if you remember about a plateau somewhere around the mid-80s and that's materialized, I think that as the software based businesses continue to rebound and get stronger, that obviously provide some upward lift to margins at the same time. It will definitely be higher in 2017, but if you remember, even our SaaS properties today maintain pretty healthy gross margins. So stay tuned, talk more about it in three months.

Gregg Moskowitz

And then for Kirill, in the UK I know it maybe a little difficult to parse just given some company specific factors that are at play but are you seeing any impact from Brexit?

Kirill Tatarinov

I think we saw some impact in Q2 actually towards the end of the quarter. I would say that right now if there is some impact it's not material.


Your next question comes from the line of Abhey Lamba. Your line is open. Please go ahead.

Abhey Lamba

I had a question on growth drivers in the Workspace's business. How are Microsoft products really helping your sales? Since customers on maintenance get upgraded for free, are you see mix improvement or more seats are attached [ph] for the products or is it kind of helping you attract new customers if you can just talk about that according to different Microsoft products that will be helpful.

Kirill Tatarinov

I think it's across the Board, I would say predominantly its existing customers, expanding the usage this is really the case where unique capability in our support of Skype for Business and deploying those Skype for Business that is really see significant acceleration in particular in financial sector and we're working with these customers and since you have, we have unique technology, we obviously get to benefit from that and I would say that part of Microsoft relationship has been working incredibly well and we have been in unique position for at least a year now and it sounds like we’re going to stay in that unique position for at least another six months if not more.

And of course, Windows 10 I think it's would be fair to say when you look at the worldwide deployment of Windows desktops, approximately if you kind of triangulate different analyst's reports, approximately 10% of those deployments run virtualized and obviously as those currently get to move to the new version of Windows, they typically go with the more recent and more advanced SKU of server of Citrix solutions and at the same time, they usually expand their usage and that's certainly something that we have started to see and we expect to see more of that as we go into 2017 which gives us increased confidence.


Your next question comes from the line of Kirk Materne. Your line is open. Please go ahead.

Kirk Materne

Just two quick ones, one or David and one for Kirill. David, I might've missed it when Kirill answered the question but I didn't catch the core margins for the business this quarter I assume there may be a couple 100 basis points ahead of the aggregate but I'm just wondering if you could give us any color on that and then Kirill, regarding some of your investment priorities as you head into fiscal 2017, can you just talk about if there is anything where you guys would want to make increase -- I know there is a big push around more direct sales on the networking side of this year, is there anything that stands out to you from an investment perspective as we head into next year? Thanks.

David Henshall

Yes, Kirk the first part of the question on margin. We haven't done a full breakout P&L yet, we will complete that in the next month or so, but I know if the 30.3% for the consolidated business would be at least 31% for the core business. So historically it's been somewhere around 150 bips higher than the consolidated number.

Kirill Tatarinov

Yes. On the investment side, obviously as David mentioned we're still in final stages of our 2017 planning but to give you our preliminary view, where we see investment priorities in go to market it is not only increasing direct selling capacity that we have been driving through most of 2016 and will continue in 2017, but it's also reinvigorating in many cases our partner channel and putting more energy and working with our partners. It served us well and we're now seeing early signals that’s working to add more breadth into business and to expand in mid-market and we expect to do more of that. On the sort of product portfolio, if there is one most significant major transformation that is happening at Citrix right now, it is cloud transformation. We started it earlier this year. We have declared that we’re all into cloud and we're absolutely going to continue and it is starting to serve us very well from awareness perspective, from the engagement perspective within our existing customers who all want to run their entire infrastructures in the cloud at some point in the future and for them to know that Citrix is going to be there with them serves as tremendous reassurance and we're going to continue to give them more proof points of how strong we’re going to be going there and how we’re going to become a leader in this emerging discipline of workspaces as a service.

And perhaps, sort of on couple additional major trends that we're embracing and that you're going to start seeing us sort of be central to, is workspaces [indiscernible]. This is overall Internet of Things taking place at people's workplace. It's really a scenario where if you imagine everything around you in your office now has certain amount of compute capacity and connected to the Internet and what magical things can you do there and Citrix being essentially workplace transformation company for the last 27 years has amazing DNA to essentially take advantage of this technological trend and give people the ability to help their people work better and work differently and we're already engaged with some of our partners and systems integrator community in particular, we’re starting to see those scenarios and we’re very engaged with some of our larger customers who are now turning into early adopters of those workplace IoT approaches.

So really exciting things happening in the industry and with Citrix being truly back on our innovation edge, we're very excited about being participant in that.


Your next question comes from the line of Michael Turits. Your line is open. Please go ahead.

Michael Turits

Dave and Kirill two related questions or complementary questions on NetScaler. One, can you talk about how big HyperScale was as a percentage of the customer base in terms of dollars this quarter and what the outlook for that is? The second question is, how are customers deploying VPX in their public cloud deployment and do you see that is completely additive or cannibalistic at this point?

David Henshall

I will take the first piece in terms of HyperScale, they would fall within that segment that we talk about as cloud infrastructure and e-commerce. It's 40% of the mix last quarter and then those what I would call HyperScale it's only a handful and that would represent a part of that market, the trend continues, the meta-trend around just capacity build out has been great. So that business whereas used to be one or two quarters per year has been strong for four or five quarters in a row now and that's one of the things that you see us lapsing really, really tough comps in Q3 and Q4 of last year.

Expect that to continue, we always have pretty good visibility on a full year basis, the quarter to quarter is somewhat subject to just the needs and capacity build out of the HyperScale. As we go into next year, as I mentioned a minute ago, part of the strategy is expanding that category so that you know you are touching what I'd call Tier 2 clouds as well as broader e-commerce providers and others as well as the capacity investments and attach motion for the other segments.

So that's what going on and overall networking. As far as VPX, remind everybody that the most important element of NetScaler is the fact that it's a software product. It's deployed across a number of form factors everything from fully virtualized data center appliances all the way down through virtual appliances and even in the form factor of a container and we get a lot of leverage by being able to utilize one code base across all those different use case scenarios.

So VPX on a license count was probably the fastest growing in Q3 and that's just a function of broad distribution. You can use that in the cloud, you can use that in your own data center, you can use that as part of a networking fabric if you will. And it's just having that base for us is what one of the things that we leverage from differentiation point of view.

Kirill Tatarinov

I was just going to add one comment on the VPX. As David mentioned, our Citrix service provider segment is growing very, very nicely and we see -- while we don't break out individual elements of what Citrix service providers deliver, through their private partner cloud, we see the share of networking in that segment overall growing and that's all driven by VPX. So I would say in that respect it is additive.

Michael Turits

Right. I guess my one build out on the VPX question is, are customers deploying it in public cloud and are they think about doing that versus adopting any load-balancing that can be offered by the public cloud vendors?

Kirill Tatarinov

Yes Mike, I'm not sure we can make a generalization. There's not enough data. I will say that the fastest growing part of NetScaler is that being consumed as a service out of Amazon marketplace, Azure marketplace etcetera, so if that’s specifically what you're asking about I'd say that we're definitely seeing that and part of the strategy around CPX obviously is to address the DevOps community for their upstream. You know when you're building applications before you deploy those into the cloud. So it's a little bit of both. It's still a small part of the overall business, but as I mentioned, it's probably the fastest growing element.


Your next question comes from the line of Ed Maguire. Your line is open. Please go ahead.

Ed Maguire

I wanted to ask about the changing use scenarios around Office. Historically a lot of your customers have used -- have run office on XenApp but with the migration to Office 365 does this change how your customers are using the Xen platform?

Kirill Tatarinov

We don't say material change on how they use Xen platform. The majority of our customers use office with office expansions. They continue to run those extensions virtualized, we see many customers running their -- essentially their exchange servers and Office 365 but we see lots of customers still preferring to use office deployed on their desktops and on their laptops and their devices which Office 365 allows and we will continue to see enterprise IT preferring to run those applications virtualized from either their own data centers or from essentially Citrix running at public cloud.

So I would say no material change, and I think overall Citrix and Microsoft working so closely together and Citrix being prime delivery mechanism of virtualized application from Azure, I see that as a neutral to positive shift as those customers go to more cloud deployments.

David Henshall

Ed, I would just add one thing. If you think back your question from 10 or 20 years ago where remote access to email was the primary use case for a lot of customers, that's changed dramatically over the years and so when we look past some of the really pressing use cases like security and whatnot, workforce mobilization as a broader topic is actually really a big deal right now and that's not just thinking about one or two apps but the entire infrastructure that allows every worker regardless of where they reside to effectively be mobile and companies are doing that in pretty broadscale both from an engagement standpoint but probably more importantly from a real estate consolidation point of view and just ways to increase their density and immediately bring down costs. So that's just another phenomenon we're seeing.


Your next question comes from the line of Brad Reback. Your line is open. Please go ahead.

Brad Reback

David just real quickly on Capex for next year, should it be about $100 million given that the GoTo business has been running at about $50 million?

David Henshall

Yes I think it's a good planning number at this point. I mean, again this is one of these things that once we get through the merger we will be able to talk about a lot more granularity, but a couple of statements I made earlier about cash flow and the fact that 80% to 90% of cash flow from ops come from the core business and I would just plan around those general assumptions at this point and then over the next three or four months we'll be able to dig into that a little bit more.


Your next question comes from the line of John DiFucci. Your line is open. Please go ahead.

John DiFucci

David, question on Workspace Services. Was the CSP revenue -- I just want to make sure I understand this because you said that last quarter it grew 37% to $75 million in ARR. And then you said this quarter I think you said it grew 30% to $75 million I know this quarter those are round numbers. I guess can you just explain to us, is ARR the entire subscription run rate or is it new subscription because some people define it differently and was it flat quarter to quarter? Is that what you are saying?

David Henshall

No. It is the entire subscription run rate for that business, that's the total revenue for that business and when we talk growth rates, I'm just measuring that on what the ARR was this year versus what it was last year.

John DiFucci

Okay that's clear. And then I guess, how much of that business then is new business signed in the quarter because you said it's the entire ARR? Can you tell us how much new business or new ARR was signed in the quarter or how much new revenue? Because if ARR was $75 million last quarter and that was $75 million this quarter, that would imply there is no new business signed this quarter which I would assume there is some.

David Henshall

There definitely is. On a sequential basis and once we get the merger done and we're reporting on fewer moving parts, we'll dig in a little bit more on standardized ARR. Right now as I mentioned a couple of times, total recurring is only about $225 million of the base. So if you want to talk specifically about CSP, that product license revenue grew about 5.4% sequentially from Q2 to Q3.

John DiFucci

Okay. Could you tell us about how much the revenue is from CSP in the quarter?

David Henshall

Yes. It's 1/4th of the ARR number that I have given.


Your next question comes from the line of Keith Weiss. Your line is open. Please go ahead.

Keith Weiss

I think the question for David, but as we think about 2017 and eCommerce that’s going on in the cloud we see some of the growth parts of your business are coming from more and more subscription sources. Should we think about an increasing headwind on that license revenue line as we go into 2017 from shift towards more substantial license, is it amortizing off the balance sheet?

David Henshall

No. Not in 2017. I think this is more a 2018 through 2020 story at this point in time do not expect it to have a material impact on the P&L. We have accounted for the modest uptake in our guidance and I think as we get into the second half of next year or maybe at our analyst meeting we can talk a lot more about how we look to accelerate those plan over the next several years, but not in the short term.

Keith Weiss

And then for Kirill, definitely I want to talk about security this quarter, just want to go in for basis [ph], are we talking more about just a security use case for a poor set of products that are already good for executing on a security use case or is this a shift in terms of product [indiscernible] security more -- putting more security functionality and maybe to the ADC boxes or more discreet security functionality in terms of what you guys are delivering in Workspace Services that would require new functionality through M&A or organic development?

Kirill Tatarinov

Well I think it is both. I would say most importantly it's emphasizing the benefits that we're already delivering and we have just been hiding it for lack of a better word being somewhat not as vocal explaining to people what benefits we already bring through our solutions, that's first I would stress and highlight and that’s what you saw and we're actually seeing positive response from industry analysts when we explained what we were doing last month. The feedback was very positive and you may have seen some of written about it. I think the second is we've continuously driven innovation in this area across NetScaler in that family and ShareFile, addressing increasing needs of cybersecurity defenses in our existing customers and future customers. And of course, we continue to look to improve it and to do even more in the area of cybersecurity for our customers both organically and in organically as well.


Ladies and gentlemen we have reached the end of our allotted time for questions and answers. I will now turn the call back over to management for closing comments.

Kirill Tatarinov

Folks, I really want to thank you for joining us today. And thank you so much for following Citrix as we continue on our journey to making Citrix better than ever. Obviously, we have had a great quarter and we're very proud of our transformation and restructuring that we have driven so far and the results that we're able to share with you.

Our operational rigor and our execution has certainly been very strong and we continue to drive it forward as we finished 2016 and enter 2017. It is truly exciting to see our hard work being validated by our results. It's great to see the progress that the team is driving. And I think there is huge additional opportunity in front of us across broad portfolio of solutions, across very motivated and engaged employee base, strong partner channel, great customers that love and support working with us and we're really looking forward to the future engaging with you in the coming weeks and months. Thank you again for joining us today.


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