Good afternoon, and welcome to the F5 Networks 4th Quarter And Fiscal 2018 Financial Results Conference Call. At this time, all parties will be able to listen only until the question and answer portion. Also 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 Mrs. Andre Long.
You may proceed.
Hello, and welcome. I'm Suzanne DuLong, F5's Vice President of Investor Relations. Francois Donot, FI's President and CEO and Frank Peltzer, FI's Executive Vice President and CFO, will be making prepared remarks on today's call. Other members of the F5 executive team are also on hand to answer questions during the Q and A portion of the call. A copy of today's press release is available on our website at f5.com, where an archived version of today's call also will be available through January 23, 2019.
The telephonic replay of today's discussion will be available through midnight Pacific Time on October 25th and can be accessed by dialing 866-397-1432 or 203-369-0539. For additional information or follow-up questions, please reach out to me directly at esturlongf5.com. Our discussion today will contain forward looking statements. Which includes words such as believe, anticipate, expect and target. These forward looking statements involve uncertainties and risks that may cause our actual results to differ materially from those expressed or implied by these statements.
Factors that may affect our results are summarized in the press release announcing our financial results and described in detail in our SEC filings. Please note that F5 has no duty to update any information presented in this call. With that, I'll turn the call over to Francois.
Thank you, Sudan, and good afternoon, everyone. Thank you for joining us today. Overall, we executed and overachieved our 2018 plan and continue to align to our Horizon 1 and Horizon 2 goals driving growth and strong operational results across the business during fourth quarter. We are seeing significant traction for the long term vision we outlined in our March 2018 Analyst and Investor Day, and furthering momentum in software and security sales. Customers continue to view our solutions as mission critical in hybrid environments as they deploy incremental workloads dynamically both on premises and in cloud environments.
Our product revenue growth continued in Q4 with products delivering 3% growth led by software. Public Cloud continues to be our strongest software growth area with an increasing demand for security solutions. We expect our cloud native offerings will allow us to extend that growth and expand our public cloud reach in 2019. In addition, we continue to and virtual edition subscription consumption models. Good initial deal closure and strong pipeline growth indicates these new consumption models will be especially important with Systems continue to show resilience with growth opportunities in certain geographies, including China and Latin America, and with customers that want to control and manage the end to end application delivery solution and certain high performance use cases.
Rounding out the business drivers, our services business continues to perform well, delivering 6% growth in the quarter. We are seeing consistently strong attach rates on maintenance and driving continued year over year deferred revenue growth. We're particularly proud of our continued world class customer satisfaction scores, reflecting our relentless commitment to our customers and their increasingly complex application deployments. Preferred remarks. But right now, I'll hand the call to Frank to review our Q4 and fiscal year 2018 results and our outlook for the first quarter
Thank you, Francois. As Francois noted, we drove strong financial and operating results in Q4 and for the year. 4th quarter revenue of $563,000,000 was up approximately $5,000,000 to $565,000,000. GAAP EPS of $2.18 per share was well above our guidance of $1.77 to 1.80 per share. Non GAAP EPS of $2.90 per share was also well above our guidance of $2.61 to $2.64 per share.
The beats for GAAP and non GAAP EPS were driven largely by strengthened revenue, expense discipline and lower than expected effective tax rates. Q4 product revenue of $256,000,000 was up 3% year over year and accounted for approximately 46% of total revenue. Software was approximately 17% of product revenue and grew more than 19% year over year. Systems revenue made up approximately 83 percent of product revenue and grew 18 basis points year over year. Services revenue of 306,000,000 grew 6% year over year and represented approximately 54% of total revenue.
On a regional basis in Q4, Americas grew 1% year over year and represented 55% of total revenue. EMEA revenue grew 8% year over year and accounted for 25% of overall revenue. APAC revenue grew 11% year over year and accounted for 15% of total revenue, while Japan grew 15% year over year and accounted for 5% of total revenue. Sales to enterprise customers represented 66% of total sales during the quarter. Service providers accounted for 18% and government sales were 16%, including 7% from U.
S. Federal. In Q4, we had 4 greater than 10% distributors. Ingramicro, which accounted for 18% of total revenue, Tech Data, which accounted for 11% and West Conenero each at 10%. Let's now turn to operating results.
GAAP gross margin in Q4 was 83.4%. Non GAAP gross margin was 84.7 percent. Both GAAP and non GAAP gross margin were slightly better than our expectations, driven by strength and services margin as we continue to leverage automation to optimize our support organization. Last quarter, we took steps to further align investment with our transformation to a leading provider of multi cloud application services. Specifically, we are accelerating investment in our roadmap and market development efforts in the fastest growing opportunities of our business, cloud and security.
As a result, we which are reflected in our 17 to $329,000,000 guided range, driven largely by operating efficiency and lower than expected restructuring expenses. Non GAAP operating expenses were within our guided range at $263,000,000. Our GAAP operating margin in Q4 was 27.3 percent lower than anticipated due to tax benefits associated with our stock based compensation expense in the quarter. Our non GAAP effective tax rate was 19.2 percent. GAAP and non GAAP effective rates also benefited from year end adjustments related to our domestic tax filings as well as our mix of profits In Q4, we generated $204,000,000 in cash flow from operations, which contributed to cash and investments totaling $1,450,000,000 at year end.
DSO at the end of the quarter was 47 days. Capital expenditures for the quarter were 17,400,000, Inventory at the end of the quarter was $30,600,000. Deferred revenue increased 5.3% year over year to just over $1,000,000,000. On employees. Our restructuring initiative in Q4 impacted approximately 215 employees.
Executing on our plan to invest in our strategic growth initiatives, during the quarter, we hired 150 employees and ended the quarter with approximately 4000 4 ten employees, down approximately sixty five people from Q3. We continue to hire aggressively in our growth areas. In Q4, we repurchased approximately 864,000 shares of our common stock at an average price of $173.69 per share for a total of 115,000,000. Quickly recapping our fiscal year results. For the full year, total revenue grew 3.4 percent to 2,160,000,000.
Product revenue of $960,000,000 decreased 0.5% from the prior year and accounted for 44% of total revenue. Within product revenue, software revenue grew 23%, while systems revenue declined 4% over the same period. Services revenue of $1,200,000,000 grew approximately 6.7% during the year and represented 56% of the total. GAAP net income for FY18 was $454,000,000 or $7.32 per share, and non GAAP net income was $612,000,000 or $9.87 per share. In FY18, cash flow from operations totaled $761,000,000 and capital expenditures were $53,000,000.
Now let me share our guidance for fiscal Q1 of FY19. Unless otherwise stated, please note that all of my comments reference non GAAP operating metrics Overall, we remain confident in our position in the market and in the growth opportunities for the business with solid software momentum. We believe the long term trend toward multi cloud environments is strong and will be a fundamental growth driver for the solutions we offer today and those we will launch in 2019. With this in mind, as well as factoring in our normal seasonality, for the first quarter of FY2019, we are targeting revenue in the range $542,000,000 to $552,000,000. We expect gross margins at or around 85%.
We estimate operating expenses of $265,000,000 to $277,000,000. We anticipate our effective tax rate for the year be between 21% 22% with some fluctuation quarter to quarter. Our Q1 earnings target is 2.51 to $2.54 per share. In the quarter, we expect share based compensation expense of approximately $39,000,000 and $2,000,000 in amortization of purchase intangible assets. Finally, as has been our practice, we want to provide you with broad modeling assumptions for FY 2019 fiscal year.
As we discussed in March of our investor conference, we are tracking to our Horizon 1 outlook with our FY19 operating plan. For FY19, from a base of Q1, we anticipate sequential revenue growth throughout the year. We anticipate gross margins at or around 85 percent for the year. We expect operating margin in the mid-30s range, in line with recent year's results, Moving down slightly in Q2 and Q3 from Q1 and then in Q4 in the upper 30s. Stock based compensation is anticipated to be in the range of $155,000,000 to $165,000,000 for the year.
Capital expenditures are expected to range from $110,000,000 to $130,000,000 for the year. This range which includes approximately $70,000,000 in costs related to our previous announced move of our corporate headquarters to F5 Tower in Downtown Seattle as we ready the space for occupancy this year. With that, I will turn the call back over to Francois. Francois?
Thank you, Frank. As you can see, we're making good progress I'll spend a few minutes highlighting some customer wins and use cases from the quarter. Net op include our prepared remarks, with comments about drivers for fiscal 2019 and our evolution to a multi cloud application services company. The first customer win, I'll talk to Spotlight F5's role in network function virtualization. During the quarter, a large Tier 1 service provider selected F5 in an initial 5G VNF deployment based on overall performance and our addition platform's ability to consolidate various functions within the core.
Importantly, the customer expects to use this as the baseline for their future virtualized core designs. I mentioned in my earlier remarks, that we continue to see cloud value proposition, offering customers insurance against the uncertainties associated with cloud deployment, including providing timeline flexibility. As an example, we secured an provider, who provides a software as a service offering. An existing F5 customer, this customer required the same level of 5 application services they had on prem as they moved to the public cloud. The ELA structure was important because it provided the agility they needed as they scale their offerings over time.
An added bonus F5's ability to provide multiple services enabled the customer to consolidate several security elements of their existing infrastructure. Turning to our security offerings, advanced web application firewall or advanced WAF continues on a solid growth trajectory. F5's Advanced WAF provides a powerful set of security features that keep web applications safe from attack. In one deployment during the quarter, we replaced the competitor in a virtual edition software environment specifically because of our bot detection and mitigation capabilities. We were also deployed by a managed care provider who is moving to the public cloud to reduce the time to turn off new customer applications.
We worked with the customer to move critical applications from shared at 5 appliances to dedicated high performance virtual additions extending the same on prem policies to their cloud deployments and replacing application security manager or ASM with Advanced WAF on the existing F5 appliances, while deploying virtual additions with Advanced WAF to support new applications in the public cloud. This customer will also deploy our BIG IP Cloud Edition to support new apps going into the public cloud. And these are just a few examples of wins the sales team is driving. Let me close our remarks today with some thoughts about fiscal 2019. Last quarter, we spoke to our efforts to repurpose investment to focus on growth areas and ensure our development and sales efforts were aligned with our most significant growth opportunities.
As Frank noted, we're adding resources in priority areas and extending our software portfolio and stand alone security products. As a result, we've got several new drivers to move toward in fiscal 2019. 1 of these drivers is our big IP cloud edition. A bundle of our Big IQ centralized managed solution and Big IP Virtual Edition sold on a per app basis Cloud Edition helps us address a large subset of applications by reducing the total cost of ownership of providing application services while providing more applications management. We have strong conviction that Cloud Edition is addressing new use cases and will be instrumental in expanding our multi cloud platform strategy.
While not yet a material contributor to our revenue, the platform's ability to provide a single management control for both on prem and cloud application services is resonating strongly with customers and the regional demand we saw for the product immediately following its release in April 2018 has now turned global. We are seeing strong interest and demand across all our territories, and we expect sales activity to increase in fiscal 2019 as we build customer references. In our security portfolio, we've got a new standalone version of SSL orchestrator scheduled for release in December. The amount of SSL traffic is growing rapidly requiring customers to use significant resources to break an inspect for security purposes. F5's SSL orchestrator has gained strong traction as a solution on a range of F5 platforms and we expect its availability as a standalone product to enable increased penetration with security buyers.
Designed to optimize customers SSL infrastructure by providing security devices with highly efficient visibility of SSL encrypted traffic It also supports policy based management and steering of traffic to existing security devices through service training. This makes it easy to integrate into existing architectures enabling customers to easily apply corporate security controls to all their encrypted traffic. We're already building a strong pipeline for the standalone SSL orchestrator offering, particularly with enterprise and government customers, and the sales team is very excited about the opportunity to we are also making good service at our Analyst And Investor event in March of 2018, we said we expected to launch in 2019. At this point, I am pleased and are starting to build pilots for lighthouse customers. In concert, we are working internally to build the muscle that will enable us to target the spended customer set, we expect this product will appeal to.
Our internal digital transformation efforts include expanding our digital touch motions to ensure frictionless procurement and service renewals. At the March investor event, we also highlighted the investment we're making to deliver cloud native application services in FY19. This program is also on track for launch in the first half of calendar twenty nineteen. Our innovation teams have built out functionality that enables intelligent traffic management services and an API first interaction model across select private and public clouds. I've seen the product demos, and I am looking forward to sharing more as we progress with our efforts to unlock maintenance demand through lighter weight offerings optimized for CICD workflows.
In addition to pushing forward with our multi cloud focused solution set, we're also building our public cloud expertise. I am pleased to announce that Barry Russell has joined us 5 from AWS to succeed Chad Whalen in meeting our cloud sales team. Barry is a business development, sales and operational leader who brings us 20 plus years of experience. Most recently, Barry was General Manager of Global Business Development And Field Operations for the AWS marketplace and service catalog where he built the AWS marketplace ISV ecosystem and digital software catalog. Barry's prior leadership roles include business development and service provider sales leadership at Microsoft as well as roles at Mivio and level 3 communications, and we're very excited to have him on board to further F5's expansion into multi cloud opportunities globally.
Barry joined another former AWS colleague, Venue Aravamuddin, who joined F5 in fiscal 2018 to lead our F5 as a service business. Venue is a seasoned software executive and expert in cloud Computing with leadership experience spanning product development, product management, program management and product and solutions marketing. He's leading edge experience with public cloud services and infrastructure platforms, services development, deployment and operations, and enterprise IT transformation to cloud made him ideal to lead our F5 as a service program. Prior to joining F5 in 2018, Venu was general manager in the Amazon relational database services business unit and previously held leadership roles at Limelight Networks VMware and Microsoft. We're excited to have both Berry and Venues Cloud expertise at F5.
In closing, I'd reiterate that we are making meaningful progress toward our long term vision for F5 with continued momentum in software and security solutions. My thanks to the entire FI team and our partners for the progress we've made. As a team, we're excited about the year ahead and we look forward to reporting on our continued
Hello, and welcome. I'm Suzanne DuLong, a Vice Vice President. Madeline, could you open the call for Q and
you. And our first question comes from the line of Radal of Provencyx. You may proceed.
Yes, hi guys. Thanks for the question. I just have a couple. I wanted to I guess first ask about software sales growth. And I mean, it's a healthy sequential growth there, but it's kind of decelerating a little bit.
And not sure what we should be reading into that. We only have a couple of quarters here, but we calculate year on year growth at 19% down from 24% last quarter. So trying to figure out kind of what do you guys think the right growth trajectory for software is is the first question And then the second thing that I wanted to ask about is just tariffs and really production, where are you producing product and how much of it is in China? And if there is any in China, what your plans maybe to move out of China would be? So if you could address that, that'd be great.
Thank you.
Hi, Rod. Thanks for the questions. I'll take your question on software and Frank will take your question on the manufacturing in China. So the first thing, Rod, on software, I tell you, no, you should not read anything into the 19%. I am very excited about where we're at on software, generally and where we're going into 2019.
The context for the Q4, nineteen percent is, first of all, our software as a percentage of overall revenue still relatively small. So as I shared last quarter, it can be lumpy from quarter to quarter, but the general trends are going to be what we've said. We specifically for this quarter, we had a tough compare to Q4 of 2017, which was a big software quarter. I think that's part of what you're seeing in this growth rate that's a little less than last quarter. But if you look overall, in Q4, 17% was sorry, software was 17% of product revenue.
So we're up from 15% in prior quarters. And as a percentage of the mix, we're on trajectory to achieve our Horizon 1 goals. I said I'm very excited for where we're at on software and that's because of what I foresee is going to be happening in 2019. So at our Analyst Conference, we said we would be in Horizon 1, which was 2019 2020. We said we would see software growth that would be in the 30% to 35% range.
And I feel confident we're going to be in that range. We've got a lot of things driving software growth in 2019. First of all, I'll point to, just three of them. First of all, we're seeing really good momentum on our ELAs, these enterprise license agreements. They're driving a larger deal size And they're also allowing us to expand our use cases and start to take footprint, for either from either cloud native or different open source of virtual ADC competitors with these, with these new model of consumption.
So that's going to drive growth in software. Our cloud addition is, ramping very well from the 1st 4 months we've had in the market. So we expect a meaningful contribution of cloud addition in 20 19. And then as you probably heard from the script, we also have new products that are coming now in the first half of twenty nineteen. Both that fabulous service and our cloud native app services platform.
So we've got very good drivers in 2019 and I expect we're going to be in the range that we've discussed for Horizon 1. Frank, on the China?
Sure. So, Rod, in relation to your question on tariffs, unrelated to the, to any sort of trade war escalation. We actually had a plan to move our production manufacturing from China to Mexico, which we completed that transfer in FY 2018. And so we're all done and complete with that. We've actually taken a look at where the tariffs are today.
And the impact that would have on our, FY 2019 operating plan, it's approximately $1,000,000 of additional costs based off the tariffs that we've already baked into our operating plan and the guidance we've given you.
Let me just follow that one up because we this may be instructive for other companies as well. You guys have already made that move. Did you, did you find it? I mean, we didn't really see it in the numbers. So it seems you have gone smoothly.
Did you find it had any impact on your inventories or anything else in the business or was it did you find it pretty easy to do, I guess, I'm just curious about that.
Look, we brought the, we started this move, last year in the early part of last year. I think the team just kudos to our, both our supply chain and manufacturing team They executed very well on the move. No, we did not have an impact, on inventories. Frankly, we made the move while staying with the same contract manufacturer. And so it was the same Centimeters that was supporting us in China that supporting us in Mexico.
And I think that, that made things smoother. And so generally, there's been no no impact. And we have continue to have very high quality of the outputs that are coming both out of the China manufacturing environment and the Mexico Manufacturing environment.
Appreciate that. Thanks, Francois. Thanks for the answers on software too. It's very helpful.
Thank you.
Our next question comes from the line of James Fish of Piper Jaffray. Your line is now open.
Hey guys, good quarter and thanks for the questions here. I would say I would like to start off on sort of the billings here and the deferred revenue. Billings were down about 1.5% year over year. Actually down sequentially in a seasonally strong quarter. The implication would be that it was on the maintenance side given the upside on the year.
I know, Francois, you talked about the strength of renewals and attach, but I guess were you having to discount more on the maintenance And then just along with that, as we're thinking about 2019, what's the impact on, of adopting ASC 606 with guidance here?
Sure. So, Jim, it's Frank. I'm going to take both of those. Let me start first with the deferred question. On the deferred revenue, we actually it was a very simple explanation on that.
We saw at the end of the quarter, a few customers with some larger renewals that, just were trying to manage their own cash. And so you're going to see that reverse itself in Q1. And then on the 606, we have a very, very small de minimis impact, frankly, from the from the change to 605 to 606 that we've discussed in our financial statements for the past couple of years. And so the guidance that we've given reflects the 606 impact, but it's it is very minimal. And we've seen the same attach rates and did not see any unusual discounting sense.
Okay, great. And then just one more for me. Any sense to how pricing changes any more color you can give? I know we talked about it a little bit at the Analyst Day, but any color between the appliance version compared to the the big IP cloud version that's coming, I get that gross margins improve as it is software, but are we talking about a 20% to 30% price reduction?
So James, the, let me make sure we're, we're, aligned here on the So generally, you'll see that our average deal size, hasn't changed. It's still in the 120 k range and it has been for the last several quarters. What you're talking about is a sort of unit price of a virtual addition classic virtual edition of F5 versus the new cloud edition. But the new cloud edition, on a per unit basis, is a fraction of the price of the virtual edition, but remember that a virtual edition typically support anywhere between 5 and 10 applications. And a cloud edition is bought on a per application basis.
And so what we're seeing in the initial, deals that we've done on Cloud Edition is that the number of apps that are supported, is significant. And so overall, there's no impact on the deal size. It's about same deal sizes, what it's been on virtual additions. It's just a different consumption model, that allows more flexibility for the user to manage their infrastructure on a per app basis.
Thank you. Our next question comes from the line of Sami Badri of Credit Suisse. Your line is now open.
Hi. Thank you for the question. I wanted to get a better idea on the multi cloud deployments. I just wanted to get an understanding of some of your customers and their behavior. When they decide to come back to you for more product and they decide to move into a multi cloud architecture, on a net net basis, are they actually buying more physical ADC or more ADCs in general to deploy a multi cloud architecture?
Or is it about the same number of units when they conduct that kind of deployment?
All right. So Sorry, let's just say, in general, I would say there are, a couple of scenarios, in those deployments. The we have a lot of customers that are buying a traditional hardware motion and are adding to that virtual additions on virtual editions on prem. That's that's kind of a classic, deployment model. What we're seeing is more and more these customers also want to deploy their infrastructure in multiple public clouds.
And their desire is to manage all these instances of ADCs, as part of a single portfolio and ideally through a single pane of glass. Our ELAs enable them to do that and give them the flexibility to consume as many licenses as as they want, of software, whether they put these licenses on prem or in the public cloud. Initial I'm talking about software purely right now. The initial view we're seeing from the consumption of these ELAs is very strong. I.
E. They signed up for a minimum amount of consumption. And we're seeing in the early months of consumption that they're well on track to exceed that minimal amount of consumption, which bodes well for true up, in the future. What we've seen as it relates to hardware is that generally customers that use us in a multi cloud, deployment scenario, overall spend more with us than customers that use us just in a traditional hardware deployment models. So that's, I think, how I would frame it for you.
Is the overall spend for multi cloud customer is larger than one that is not or the one that is pure hardware.
Got it. Thank you. And then just as a follow-up to that, do you see very similar services revenue attached to those same type of deployments or is it a little bit different?
No, it's very similar. The only difference, Sami, is that when a customer signs up for an ELA or a subscription, their services, is part of the subscription. And so it will show up for us in our product revenues, whereas in a model where they bought the hardware as a perpetual license and separately, they bought maintenance that services would show up in our, in our services revenue. So there is a difference in terms of where the services revenue is going to be accounted for. But in terms of the if you are total customer spend, is the same or potentially in terms of the amount of money they're spending on services, is the same or potentially larger if we are successful with the renewal and the extensions that we're seeing in the early days?
Got it. Got it. Thank you.
Thank you. Our next question comes from the line of Tim Long from BMO Capital. Your line
Ma'am, are you still there?
Hello?
Tim, your line is now open.
Okay. Can you hear me?
We can, Tim. Sorry.
Sorry about that. I was just, they hadn't even muted. Anyway, back to the software line, Fritz, while you talked about cloud Edition, it sounds like it's off to a pretty good start. The sequential jump in software kind of the first quarter of cloud addition. So can you give us a sense as to how much of the contribution was from just better virtual sales and security And did that cloud edition start to at least make an impact on that software line?
And then related to that, we've yet see kind of a last few quarters with software moving a little higher, particularly this quarter. Haven't seen much in the product gross margin. Is that something that you would expect to start to move a little bit higher as they as that ramps as a percentage of sales? Thanks.
Tim, thank you. The so on the first one, we said, at the time we released our Cloud Edition that we did not expect material, revenue contribution from Cloud Edition in FY 2018. And that is the case. I would say that the contribution to Q4 was very minimal, because there is the time it takes to get through, go through the sales cycles, the proof of concepts, etcetera. And then a lot of the initial deals or initial sales which will expand over time.
So minimal contribution in 2018, but we do expect, given the traction that we've seen so far, we do expect meaningful contribution in our fiscal 2019. In terms of the gross margins, The FB answer is no different than what we've stated in, but over time, We do expect, as the software contribution grows to have some impact on our positive impact on our gross margins, If you recall, at the end of our Horizon 2, which is 2022, we expect that our software to be about 40% of, of total product revenues. I think by then, we would see, a meaningful impact. That being said, our margins are roughly 85% right now. And so the room for extension, isn't significant.
What we said is that in Horizon 2, our margins would be in the 85 percent to 87 percent range. So it's incremental, but small and a big scheme of things.
We're tracking to the Horizon 1, Horizon 2 guidance in that regard.
Okay. And then just a quick follow-up on the cloud addition. Could you just talk a little bit about are you seeing any kind of new customers added to F5 by these new offerings? And do you expect that with the next software offerings in the first half of next year that I'm done. Thank you.
Yes, thank you, Tim. So I would say, we continue as a company, we continue to win new logos every quarter, and that's not really driven just by Cloud Edition. We're winning new use cases in security, in public cloud, and even mentioned last quarter, a number of new customers coming in for hardware. So new customer new logo acquisition is going to continue. What we're seeing with Cloud Edition is within our existing customers, we are unlocking new footprint, that we didn't have before.
They're a couple of use cases that we could not address before. One is when customers want to really deploy it on a per app basis, We couldn't touch those types of deployments. We now can. 2 is the ability to scale, rapidly the infrastructure under an application, that sort of flexibility is a new use case for us and it's expanding our footprint and touching new applications. Specifically applications that are in test and development.
We didn't have the opportunity before to intercept these applications that they're inception, and we now can. And the third aspect of that is, we are also now, for the first time, giving application developers direct visibility into, their virtual instance of F5 And they're seeing analytics and the performance of their applications. And so we're building a relationship with app developers that we didn't have before, and that's driving new deployments into new applications. So I would characterize it right now as largely addressing the long tail of applications you've heard us talk about inside of existing customers more than focusing on going and looking out for new customers. I do think that we will address new customer segments, as we introduce, in the first half of twenty nineteen as part of the service and our cloud native app services platform.
Thank you. Our next question comes from the line of Jason Ader from William Blair. Your line is now open.
Thank you. Frank, could you, talk about linearity in the quarter and just give a sense of how that's similar or different than what you've seen in the past into Q4. And then, Francois, on the systems side, looks like that's recovered a bit. It was a flat year over year. Which I think is an improvement of what you've seen over the last several quarters.
Can you talk about what's driving that?
Sure. So, Jason, thanks for your question. I'll start and then turn it over to Francois. The linearity one is fairly straightforward. It was almost identical to what seen in the past Q4s.
And so, we were, if anything, saw even a little bit of better in Q in month 1 and month 2. But we're talking a percentage point, nothing dramatic.
Jason, in terms of the, the systems, if you recall, in March, we said that we expected the overall market, for hardware ADCs, to decline at mid single digits going forward. But we also expected that we would do better than that. We expect it to be in the low single digit decline to flat. Going forward. And I think what you've seen over the last three quarters is we've done exactly that.
In this quarter, we were we were flat. We still expect quarterly fluctuations on the hardware number, but overall, we're executing and I think we're getting share. And there are a couple of reasons for that. One driver of the stability is security use cases, driving spend in ADC for us, but not all ADC vendors have access to it because they don't have the security capabilities. Things like SSL, orchestration or web application firewall or access manager consolidated on ADC.
That's driving, stability for us at ABC. There are new use cases, such as fits in the federal sector or IoT that are driving demand for our hardware products, there are geographies where there is significant demand for new hardware, specifically in the emerging markets places like China and Latin America. And so all of these factors are driving stability in the hardware business, along the lines of what we have said would happen at the investor meeting.
Our next question comes from the line of Alex Kurtz of KeyBanc Capital Markets. Your line is now open.
Yes, thanks. Just a couple of quick questions here. I just want to follow-up on the new customer question from earlier around cloud additions. I think there's a broader view of a lot of traditional on premise software companies that they won't be able to capture the cloud native application or the company that maybe just starts fresh in the cloud. And I think there's been some talk of companies like yourself that are building software in the cloud platforms, find the customer, then maybe there's even an opportunity on prem down the road.
So Can you just double click on that a little bit more? I know you briefly touched on it, but I just want to have you seen cases like that or it's just too soon to know?
Well, Alex, if that's what you're referring to, we have seen cases, and I wouldn't say we're seeing them by the hundreds. But we have seen cases of companies that were born in the cloud, and essentially never never bought or owned a piece of infrastructure And as they grow and start to worry a bit more about their profit, they start worrying about how they control their costs. And we have seen some of them almost graduate from this boarding the cloud environment and come back and rent colocation capabilities and actually come back to us for hardware ADCs. So we have seen those cases. I don't know if this is a trend that's going to be, much stronger in the future than it is today, but we are seeing that.
But as it relates to, acquiring customers directly in the cloud for companies that were historically on prem like us, We think it's an opportunity that largely for us is untapped today because you're right, we don't play that market today. But that's why we're quite excited about F5 as a service coming in the first half of twenty nineteen, because that's going to allow us to really intercept is bought in the cloud applications in a native cloud consumption experience, for those who are building their app in the public clouds, platform environment. And so we're pretty excited about our opportunity to play there and intercept these applications. And then down the road, as these applications grow, if they too have multi cloud requirements, it will make it that much easier for us to contribute to their requirements beyond the single public cloud. And, so as part of the service, essentially, will be our leading entry into the relationship, which we will expand from.
That's very helpful. And just back on the current environment with tariffs, higher interest rates, a very strong calendar 2018 for IT spend. I think there's a lot of concern heading into 2019 that things may not be sustainable. I mean, when you talk to your larger enterprise customers, what's been sort of the initial feedback on how they feel about spend over, say, maybe the next 6 months or so?
I would describe it, Alex, as generally the spending environment, you're right, has been healthy in 2018. We continue to think overall that it's healthy. So specifically for the enterprise market, in North America, in particular, we've seen some softness in the Tier 1 service providers, in the last quarter and cautious about the upcoming quarters, with tier 1 service providers. There hasn't been a sign of significant change in behavior from our enterprise customers. But like everybody else, we are a little cautious going into 2019, given what we've seen over the last 3, 4 weeks.
Our next question comes from the line of Samik Katterjee of JPMorgan. Your line is now open.
Hi, Frank. So, hi, Frank. Thanks for taking my question. I just wanted to start off with the growth that you're seeing in the cloud. You mentioned you're seeing strong growth there.
Can you remind us within amongst kind of the Tier 1 and Tier 2 cloud providers, who do you have existing partnerships with? And how should we think about kind of have you seen any interest from additional cloud providers and how should we think of that as an enabler of stronger growth in software?
Yes. So we have relationship with the major public cloud providers So AWS obviously is a partner for us. Microsoft Azure is a partner. We have integration going into Google Cloud, and international cloud providers as well. And the relationships aren't just technical integration.
Certainly in terms of the top 2 or 3, there's significant co marketing activity, between us and them to help customers leverage their cloud and migrate applications, over to the cloud. And so in the software, we don't break out, by the way, as you know, Savik, we don't break out our our public cloud revenues. But we have said before, and I can reiterate this that within software, software in the public cloud is the fastest growing part of our software business. And that has been the case throughout 2018.
Got it. Got it. And then if I can just maybe this is more for Frank, but if I kind of look at your guidance, I think you mentioned that coming off the 1Q base, you expect sequential improvement in the revenues in through 2019, that seems like typically more visibility than you've had typically. And correct me if I'm wrong on that and seems like more about the piece of improvement there. Is there something more specific that's contributing to that?
Is it more about kind of sequential acceleration in the software revenues or anything else contributing to that higher visibility even on the quarterly cadence of revenues?
You know, Swig, honestly, I think it's fairly consistent with what we've said in past in terms of our sequential improvement. It's the cadence in which our quarters generally fall. I think we're obviously happy about the traction that we've seen in software and continue to see in the software visibility that we've got. That actually, that's got nice predictability for us. And so that gives a base in and of itself.
But in terms of the specific, qualitative guidance for the broader FY 2019. That's fairly consistent to where we've been in the past.
Got it. Great. Thank you.
Thank you. Our next question comes from the line of Tal Liani of Bank of America. Your line is now open.
Hi guys. I'd like to ask a question on security. First, it's what's the level of security revenues right now? I know you didn't disclose security as a percentage of sales revenues in the past. Do you have any kind of disclosure?
And if not, when, what needs to happen for you or what level of revenues need to happen or need to materialize for you to disclose security? Second is when you look at 2019, What's the roadmap for addressable markets for security? Meaning, what what are you going after? And if you can give us also snapshot though, the current offerings of security, where do you see success and where do you still need to work on? What do you what do you still need to work on?
Within the security portfolio. And then I have a follow-up question. Thanks.
Hey, pal. Thank you. That's a question in 1. We'll address them, in that order, Tal, So in terms of disclosure of security revenues, we, as you know, we don't break that out. I would say that the percentage of our ADC sales that are driven by security use cases or that include a component of security in the overall bundle, has steadily increased.
And it's, it's today, it's a mostly it's a meaningful percentage of our ADC sales. We don't break it out. It's not just a question around the size of the revenue, but it has to do with, in a number of cases, it's very subjective to determine whether a sale was driven by security or ADC or both. And so that's the reason that we don't break it out today. And there's not a clear trigger from when we will.
In terms of
your, I'll take the 3rd part
of your question, then the second one, where we have been seeing very strong success to date historically. And Kyle, I'd say that would be up until kind of the middle of 2018 was really in these consolidated use case where we it's very convenient for a lot of our enterprise customers to consolidate onto an ADC application firewall, identity and access capability, some encryption decryption capabilities, And so this use case of consolidation in the ADC and the enterprise has been extremely successful. We'll continue to be That is also true in the service provider, where our capabilities around CG Nat, TCP Optimization, carrying great firewall, consolidated, into an ADC capability is very appealing to service providers. So I would say if you look historically, the consolidation of multiple security modules and functions that allows one to reduce CapEx and reduce complexity, has played out in the enterprise and service providers. Going forward in 2019, we're very excited about 2 stand alone security use cases.
The first one is our advanced web application firewall. We've already released that product and we're seeing great initial traction. We're really differentiated relative to other players because of our, layer 7 capabilities, but also bot mitigation capabilities. And that differentiation today is on prem. But we're going to bring our WAF capabilities into a side of the service.
And we think that's going to be a big differentiator for us. And then the second one we're very excited about is, our SSL orchestration capabilities. So mid master's use case, because all enterprise customers are dealing with, the vast majority of that traffic is encrypted, And we provide a very efficient solution to encrypt and decrypt the traffic, do what we call break and inspect and then chain multiple security services together, which saves very significant dollars to an enterprise customer So these two areas, Tal, we expect them to be 2 meaningful drivers for us in standalone security next year. And if you recall, that was one of our what about growth pillars from the conversation at aim in March?
So what are the other things you need to do with your business in order to address the opportunities? Meaning, product launching product is great. It's one aspect. How about dedicated sales team need, or you don't need dedicated, sales engineers, marketing around security branding different branding? Or is it part of the ADC branding?
So can you discuss the outer activities outside of product innovation?
Yes, Sal, it's a great question. The so there are other activities, but we have been doing them already, for several years. So if you're looking at our sales organization, in a lot of cases, a lot of our accounts in specifically major accounts are already facing, the CECL committee and the SecOps buyer. So there isn't it's not like our sales team isn't capable today of selling security solutions because they've been selling them in a consolidated ADC fashion. And so they're very conversant in these solutions, but they're addressing new use cases with a SecOps buyer.
In terms of, marketing and thought leadership,
most of our customers see it today
as a security company, we have a significant muscles in security in threat research of an organization called F5 Labs that publishes research on security issues on a regular basis. And that is very well read within our customer and partner community. So there are tons of things that we don't necessarily talk about because they've been in the go to market motion of F5 now for already several years.
Thank you. Our next question comes from Simon Leopold of Raymond James. Kindly check if you are unmute Mr. Simon Leopold.
Madeline, why don't we move on to the next one and maybe go back to Simon.
Okay. That will be noted. So our next question comes from the line of Paul Silverstein of Cowen and Company. Your line is now open.
Thank you. And I'll ask you the questions as Simon probably should have asked. First a clarification, I heard you respond from the end demand question with respect to, I think I heard you say that U. S. Service provider weakened in the last 3 to 4 weeks.
My question on that is within enterprise, what are you seeing from an in demand perspective? And if we look regionally, I think you've now posted high single digit growth in the EMEA region for a fiscal quarter. The Americas were flat and they've been flat slowed single digit in the region. For the last several quarters, Asia Pac was 11% following 8% growth in the preceding quarter, and Japan was 11% falling 4% in Q3. Some of that may be easy comps in the latter too.
But my question to you is looking at the regions what accounts for the differences? You would think from an economic perspective with the U. S. Having perks up in EMEA much less, you know, somewhat counterintuitive. But is this a reflection of ongoing service provider weakness?
What's going, what is that regional information what should it be telling us in terms of the strengths and weaknesses of your business? And then I have a follow-up question.
Hi, Paul. I'll clarify first. I didn't say service might have had waken in the last 3 to 4 weeks. I said we were seeing in the last quarter or so softness in Tier 1s in North America. And as you know, service provider business can be can be lumpy.
But if you look at that also is, I think the majority of the explanation on why North America has in relative terms is more flattish than other regions. I think it's largely driven by the softness we've seen in the Tier 1 service providers, in North America.
So Francois, to be clear, if we looked at your, if we saw the numbers for your North America enterprise business, we would do something mid to high single digit growth consistent with EMEA in the other regions. Is that the case?
We don't break that out, Paul, but you
would see
a number that would be higher than the aggregate number that you're seeing here.
All right. Let me ask you one other question, if I may. First of all, to what extent historically, if we go back to the dawn of what was in load balancing back in the late 90s, which you guys pioneered along with a couple of others. And we fast forward to today. Historically, you all sold to the networking side of the IT organization with enterprise And over time, and it's still ongoing, but the locus of purchasing power seems to be shifting, seems to be in progress.
So what extent do you all have an issue? And if you do, to what extent are you addressing it? And separate from Talos Security question, In terms of addressing the application developers who have increasing power in that equation in terms of making purchasing decisions, you already have the mindshare or do you need to do meaningful work in terms of gaining the mind share among that community?
Paul, that's a great question. So the there are 2, you are correct that both application developers, and their close cousins, Devox, people are gaining mindshare and influence in large enterprise organizations. That's resulting into 2 things. 1st, for our traditional buyers, network infrastructure, buyers, typically in central IT, they want to offer a better SLA to app developers and DevOps people. And so part of our, portfolio strategy, our multi cloud strategy is to enable our current buyers to offer that better SLA.
Cloud Edition, just I just discussed earlier, does exactly that. It offers this per app capability, which means an app developer doesn't have to wait for a maintenance window for 5 weeks so that all applications can align to an upgrade. They can do their thing on their part on their infrastructure. They also get more analytics and got more visibility in their application, but that cloud edition is typically purchased by a network operations person and they use that new technology to offer a different SLA, to app developers. So that's kind of motion 1.
The solutions we're releasing in, 2019, both that side of the service and our cloud native application platform those will appeal directly to the DevOps buyer. And they will allow them to essentially procure their own technology on their terms. And so associated with that, we have a significant efforts around digital marketing, digital sales, a tech touch for these buyers, that essentially allow them to procure the trial and procure explore trial and procure the technology in the way they want to do it, which is very different than our traditional buyers currently. So that's how we will address that, that community as well, but that journey starts in 2019.
Appreciate it. Thank you.
Thank you. Our last question comes from the line of Simon Leagopold of Raymond James. Your line is now open.
Thanks. Can you guys hear me okay this time?
Yes, Simon. How are you?
Great. Yes. Doing well. Paul did ask great questions, but fortunately not the ones I was going to ask. So I wanted to go back to the cloud guys.
Given that, that AWS and Azure offer load balancing, yet you talk about them as partners. Could you maybe compare and contrast how you might be competing with them at times and using them as a way to go to market, where does it make sense for an enterprise to engage the solution offered by an AWS or an Azure versus engaging F5. For the functionality. Thank you.
Today, there are applications we don't support that are typically applications that are born in the cloud either in test or development or even in production and that I would say have relatively simple load balancing requirements. Those applications are largely addressed by the native load balancers offered by the large public cloud providers. Now in so that's where they play and today we largely play, in enterprises that have either on prem requirements or multi cloud deployment requirements. So if somebody wants to deploy, an application or a portfolio of applications in multiple public clouds, typically, we're going to have a play there because we are cloud agnostic. We will, in that scenario, partner with the public cloud providers to help the customers migrate their application to these environments.
And when F5 is supporting an application on prem and it migrates in the vast, vast, vast majority of the cases, we will stay with that application and they'll stay with us. Now in, so that's kind of the lay of the land today. In 2019, as we introduced our new platforms and as a service, We will also play in, bought in the cloud, applications, but the value add that we bring beyond the cloud native load balances is the feature depth and breadth that a lot of these applications want when they want, global server load balancing, some security capabilities And our partners, in this case, the public cloud providers are actually interested in partnering with us to enable these capabilities in their environment in a seamless way for these, for these applications. And that's, actually one of the reasons that I mentioned in the criteria that Barry and Benu have joined us from AWS. One of the reasons for that is they have, deep insights both into the economics of, application departments in public clouds and the technology associated with the deployment, and they're very interested in this multi cloud strategy and, how we're going to deploy our business in these environments.
And maybe just a quick follow-up to that. It seems as if Google Cloud has really been trying to catalyze multi cloud given that they're the 3rd player. They've got the most to gain, I believe. Where are you in terms of relationship with Google?
We have a relationship with them, with them as well. I would say for clarity though, Simon, when we talk about multi cloud, we mean by that multiple, multiple public clouds, co location, on premise private data centers and on premise private clouds. And we're seeing all of these deployment models happen within our customer base.
Great. Thanks for taking the question.
Thank you.
Thank you. And that concludes today's conference. Thank you for participating. You may now disconnect.