Q1 2020 Earnings Call
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Good afternoon, and welcome to the F. Five networks first quarter fiscal 2020, <unk> financial results Conference call. At this time all participants are in listen only mode. After the speakers presentation. There will be a question and answer session to ask a question. During the session you will need to press star one on your telephone if you're.
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Now turn the call over to Miss whose Angela.
Adam you may begin.
Hello, and welcome I'm, Suzanne do long haul flights Vice President of Investor Relations, France, Although the new <unk>, President and CEO and Frank Pelczar have finds executive Vice President and CFO will be making prepared remarks on today's call.
Other members of the five executive team are also on hand to answer questions. During the Q any portion of today's call.
A copy of today's press releases are available on our website at <unk> Dot Com Werent archived version on the call will be available through April 26 2020.
The replay of today's discussion also will be available through midnight Pacific Tomorrow January 28 by dialing 800, 585, Athree six seven or for 166 to one for six four too.
For additional information or follow up questions. Please reach out to me directly as don't do long at a five dot com.
Our discussion today will contain forward looking statements, which include words, such as believe anticipate expected 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 or results are summarized in the press release announcing our financial results and described in detail in RCC filings.
Please note that five has no duty to update any information presented in this call.
With that I'll turn the call over to Francois.
Thank you Suzanne and good afternoon, everyone. Thank you for joining us today.
I will talk briefly to our business drivers before handing over to from to review the quarter's results in detail.
We have been investing to evolve our business to better meet our customers changing application demands.
Today, we are delivering our world class application services across a wider range of deployment and consumption models.
As a result customers are increasingly deploying a five in multi cloud environments driving a shift in our revenue mix towards software.
Customer demand for consistent application security and reliable application performance drove 5% total revenue growth in our first quarter.
Strong customer demand for security use cases, including WAF and that's the cielo as well as ongoing yoli traction.
Our 50% software growth.
We're very pleased with our continued software traction we continue to expect 60% to 70% software growth for 2020, including contribution from shapes security, which closed on Friday last week.
Oh software growth was partially offset by our systems business, which was down 11% of customers increasingly look to consume a five solutions software.
Oh services business was very strong in the quarter delivering 8% revenue growth.
So this is benefiting from a robust software sales over the last several quarters, including the second full quarter of and your next related sales.
Overall, we continue to execute well against our long term strategy and are pleased by the pace of our continued transition to a software driven business.
I will speak more to our business dynamics and customer wins after Frank would use the quarter's financial results and our Q2 outlook.
Frank.
Thank you Francoise and good afternoon, everyone as friends. One noted we delivered another quarter of strong revenue growth.
First quarter revenue of 569.3 million was up approximately 5% year over year in near the top end of our guided range of 562 570 million.
GAAP net income for the quarter was 98.5 million or $1.62 cents per share.
non-GAAP net income was 155.4 million or $2.55 per share. This was well above the top end of our guidance range due to our strong revenue performance as well as disciplined operating expense management in the quarter.
Q1 product revenue of 235 million was flat year over year and accounted for approximately 41% of total revenue.
As friends why mentioned software revenue grew 50% year over year.
Software represented approximately 28% a product revenue in Q1 up from approximately 19% in the year ago quarter.
We continue to experience strong uptake on our software solutions sold its annual subscriptions, including as E.L.A.'s.
In fact contribution from E.L.A.'s increased again year over year.
Systems revenue of 170 million was down 11% year over year as customers continue to transition to software based solutions.
Systems accounted for approximately 72% a product revenue in the quarter.
Services revenue of 335 million grew 8% year over year and represented approximately 59% of total revenue.
There were three primary contributors to services revenue strong performance in the quarter.
The primary factor is improvements to the tools and processes our team uses to identify and secure renewals.
In addition, we continued to enjoy healthy services attach and renewal rates to software sold as perpetual or asked subscriptions, including engine ex related sales.
And we have also seen a step up in consulting services demand associated with growing software sales.
On a regional basis in Q1 America's delivered a solid quarter with 3% revenue growth year over year, representing 53% of total revenue.
EMEA grew 5% and accounted for 27% of revenue <unk> APAC grew 8% and accounted for 20% of revenue.
Looking at our bookings by vertical enterprise customers represented 65% a product bookings and service providers accounted for 16%.
Our government business was very strong representing 19% a product bookings, including 7% from U.S. federal.
In Q1, we had three greater than 10% distributors Ingram micro which accounted for 16% of total revenue westcon, which accounted for 11% and arrow, which accounted for 10%.
Let's now discuss Q1 operating results.
GAAP gross margin in Q1 was 84.4%.
non-GAAP gross margin was 86%.
GAAP operating expenses were 358 million.
non-GAAP operating expenses were 297 million.
non-GAAP operating expenses were at the lower end of our guidance range for several reasons, including disciplined expense management and sales commissions back in line with historical levels down from the highs of the second half of 2019.
In addition, there were some timing differences for expenses expected between Q1 and Q2.
Our GAAP operating margin in Q1 was 21.5% and our non-GAAP operating margin was 33.8%.
Our GAAP effective tax rate for the quarter was 22.8% or non-GAAP effective tax rate was 21.4%.
Turning to the balance sheet.
In Q1, we generated 144 million in cash flow from operations.
This is down from last year for several reasons, including lower year over year operating margins Commission payments from strong Q4 bookings M&A related expenses and restructuring.
Cash and investments totaled approximately 1.5 billion at quarter end.
D.S., so of 56 days and capital expenditures for the quarter were 22 million.
Deferred revenue increased 8% year over year to 1.2 billion.
The growth rate is down from 2019 levels, because we had lapped our six so six adoption, which as we consistently called out was accounting for roughly half our deferred revenue growth over the last year.
We ended the quarter with approximately 5305 employees down approximately 20 from Q4 as result of ongoing efforts to better align spend with strategic imperatives.
We continue to view cash as a strategic asset for our future growth.
Our near term priority will be paying down the 400 million dollar term loan a related to the shape acquisition funding.
We'll look to balance that with rebuilding our cash position for strategic purposes.
We also may opt to repurchase shares during any open trading window.
Now, let me share our guidance for fiscal Q2 of 2020.
Unless otherwise stated please note that my guidance comments reference non-GAAP operating metrics. In addition, with the shape security acquisition closed on January 24th our guidance is inclusive of shape.
We continue to make strong progress transitioning our business to a software driven model.
We remain confident in our position in the market and expect increasing demand for our multi cloud application services will continue to drive revenue growth. We also expect continued strong demand for our software solutions.
In fact in Q2, we anticipate software growth will reaccelerate above Q1's, 50% growth even before any contribution from shape.
As we noted when we announced the shape acquisition shape has a subscription revenue software model with a significant deferred revenue balance.
Purchase accounting will impact shape related recognized revenue on a GAAP basis, principally over the next four quarters. Therefore for that period, we will provide non-GAAP revenue guidance, which excludes the impact of the purchase accounting write down.
We believe non-GAAP revenue will provide a better reflection of our ongoing business results.
We will report revenue on both GAAP and a non-GAAP basis during this timeframe.
With this in mind, we are targeting Q2 20 non-GAAP revenue in the range of 580 to 590 million.
In addition, we expect services Q2, 20 annual revenue growth more in line with Q4 of 19.
We expect gross margins in the range of 85% to 85.5%.
We estimate operating expenses of 325 to 337 million in Q2, reflecting the addition of shape and the opportunity we have to invest and scale that business.
We anticipate our effective tax rate for Q2 will remain in the 21% to 22% range.
Our Q2 earnings target is $2.14 to $2.17 per share.
In the quarter, we expect share based compensation expense of approximately 52 to 53 million.
With that I will turn the call back over to Francois Francois.
Thank you Frank.
I'm going to begin today with a spotlight on enginetics before highlighting some of the broader trends and customer wins in the quarter.
First today, we announced an important milestone for the combined F five and Enginetics.
The availability of controller Threed auto.
Controller is our orchestration and analytics solution for Enginetics.
It simplifies how enterprises manage monitor and automate large scale enginetics deployments.
Prior to the acquisition of Enginetics five was working on a cloud native virtual SBC offering that featured an application centric design.
We expected the solution.
Corporately named cloud Native would set a new benchmark for how modern developer teams could deliver new apps to market faster.
Immediately after the close of the Enginetics acquisition in May 2019, we merged the five team working on our cloud Native project with the Enginetics controller development team.
Today as we begin only our third quarter as a combined team. We're very excited to release the converged F. Five engineer solution.
Your next controller Threed auto.
Lets controller brings together the best of Enginetics controller, one daughter went through the auto an odd the application centric design an enterprise features pioneered by a five.
For context on why this new approach is so important we first need to emphasize the fundamental shift in the way our customers manage and deliver applications.
Originally there was a divided between the application teams that develop a code and the operations teams that release and managed the finished application.
Devops evolved to bridge this divide and many organizations embraced that bops practices to deploy applications faster.
As a result organizations embraced software like Enginetics open source and engine X plus two mpower developers with control over their own infrastructure.
Although this improved developer productivity. It also created Shadow I T.
Many of these developers worked outside of IC outside of the compliance and enterprise security requirements designed to protect applications and data.
That is why we believe controller Threed auto and its application centric approach is highly differentiated.
The application centric design introduces a new self service portal configuration, Apiay application reporting and analytics and built in security capabilities.
These combined up centric capabilities and power developers from a centralized solution that maintains control and compliance for security and operations teams.
Controller Threed auto shifts the center of gravity from the instance of infrastructure supporting the up.
So the application itself.
With role based access spanning App Dev Dev ops cycles, and net ops. It enables deployment of a consistent set of multi cloud application services across the application lifecycle.
This enables different users to manage the tasks relevant to their role.
In summary, we expect the availability of controller Threed auto will be an accelerator for our engineers business for three reasons.
First.
It expands the addressable market for Enginetics to include a Jay said up services insecurity and Servicemesh.
Second it increases the average deal size by making large scale engine next deployments easier to orchestrate.
And third it introduces new commercial capabilities that are attractive to and you next is large open source base.
Early feedback has been positive with customers, noting that controller Threed auto expands the number of use cases and deployments of Enginetics, particularly for kubernetes seen gross and Epi management.
In addition to delivering the controller Threed auto release, Enginetics had its strongest quarter yet in Q1 with the team hitting all of its significant integration and value creation milestones.
When we looked at the future of a five we're more confident now than ever before that engine next will be a meaningful software growth driver.
We continue to see evidence that enginetics is expanding our overall footprint and allowing us to serve new applications. This includes enabling application services consumption in native container environments.
As an example during Q1, we secured an engine X plus an engine ex controller win with a new customer.
A large Australian mining company.
The customer was looking to modernize a legacy business process at its mine sites, where a single failure could result in up to $4 million in productivity losses.
By using engine to explore the CPI and kubernetes in their applications. The now are able to collect and deliver over 30 different metrics.
As a result, there are better able to ensure the speedy and reliable delivery of raw materials. So there are destinations.
We're also seeing an uptick for enginetics inclusion in the L.A.'s both in concert with a five solutions and on a stand alone basis.
During Q1, we closed our first 100% engineering yeley with a large streaming services provider.
And your next plus is enabling seamless capacity and service offering increases without disrupting critical revenue producing applications.
The only construct was meaningful in this case because the customer is able to deploy additional engine xplore instances of subscribers increase.
In fact, when the actual number of subscribers surpassed forecasts out of the gate. The E. coli provided the customer with the flexibility to immediately scale services with demand.
Beyond Enginetics, we continue to gain traction in software across the other growth drivers, we have consistently highlighted including Yalea service provider use cases security use cases and deployments across multi cloud environments.
I will highlight customer examples of each of these in Q1.
In fact, the first example highlights a nearly win with a large UK based telecommunications provider transitioning from hardware to software.
In this case the customers AIDC infrastructure based on five hardware was nearing end of life.
The need to refresh provided the customer with the opportunity to rethink the design and build a flexible virtualized environment aligned to its future business needs.
Despite a competitor touting analytics and commercial flexibility of five was able to demonstrate best in class software based security and AIDC capabilities.
In addition, our analytics and reporting outperformed the competition and reduce the customers operational costs.
Looking at a security use case when in the quota.
During Q1, we secured a combined systems and software win with a German health system company.
Five is providing application security solutions, including advanced WAF to secure a platform that allows doctors hospitals and health insurance companies consolidated access to patient records.
Of note, we were the only provider able to meet the customers security requirements of delivering a highly secure and scalable infrastructure that met stringent government standards.
In an example of a five solutions deployed in multi cloud environments. We secured a win with one of the UK is most trusted financial brands, a large UK based mortgages provider.
As part of their digital transformation program, they chose to deploy a big IP virtual additions across to public clouds.
That's provided the growth capability to support an ever increasing number of online banking customers and enabled consistent application services and security across the cloud and data center.
Before we moved to today, let me say, how very enthusiastic we are to begin our integration work with our colleagues from shapes security.
To recap briefly we believe the combination of five and shape changes the game in application security.
Shape is a leader in anti fraud and abuse protection solving a mission critical problems for large enterprises.
Together with a fives world class portfolio of application services shape and I've five will deliver the most comprehensive application security portfolio available.
Beyond accelerating our growth momentum and more than doubling our addressable security market shapes machine learning and AI powered capabilities also will scale and extend fives broad portfolio of application services.
With shape, we will expand our ability to optimize and protect customers applications in an increasingly complex multi cloud world with the shape transaction closing last week. The teams already have begun the integration process led by members of our Chief strategy Officer, Tom Fountain steam under our value creation.
One program.
This is the same team that executed the very successful integration of Enginetics and we are confident they will do the same would shape leveraging lessons learned during the engine ex process.
We're very pleased the Derek Smith shapes CEO will continue to lead the team as part of five.
In closing digital transformation has changed the competitive stakes for nearly every business on the planet.
Beyond delivering a compelling reliable user experience.
Customers need partners and solutions that allow them to do more and move faster.
Now that five we envision a future were all businesses can deploy new applications or make changes to existing applications in minutes not days.
We are transforming a five to make that vision a reality for our customers.
To enable support and secure every application across any environment, where they consistent set of enterprise grade services.
My sincere thanks to the entire at five team for driving another great quarter.
Hi, Thanks also to our partners, our customers and our shareholders.
Joining us on our journey.
I will remind you that our analyst and Investor Day is scheduled for March 3rd in New York.
Look forward to see many of you there.
With that operator, we will now open the call acuity.
As a reminder to ask a question you need to press star one on your telephone.
Question press, the pound or hash key.
Our first question comes from Tim Long with Barclays. Your line is open.
Thank you to two questions if I could first.
Frank I think you talked about last time, the cloud related businesses, which are still in early phase were.
Meaningful portion of the total software revenues could you just give us an update on how the the cloud vertical did for you and did you see some sequential growth there.
And if not where they're equally impacts or some other impacts.
Then secondly, the services strength it sounds like the year over year growth rate will pick back a little bit next quarter, but.
Could you just talked looking out the next several quarters or year.
Should that line start to become under a little bit more pressure as.
You know the weight of the of the system revenue declines.
Hits the hits the longer term model. Thank you.
Yes.
So I'll take the first question and then Frank will comment on services question.
On the cloud cloud revenues, Tim we said.
They represented a meaningful portion of our total software revenue.
And that portion is continues to grow.
I would.
A business is growing even faster than our overall software business.
And that's driven by a couple of things.
One is we have made our core solution.
Easier to deploy in cost environment.
With integration with.
We all the large public cloud providers.
We.
Added some.
Automation and orchestration capabilities.
Enable our customers three include our solutions in.
Well they should environment.
In there a CD development pipeline.
Much easier than that in the past.
And third I think we're continuing to see just significant growth in the marketplaces.
Of our of the large public cloud providers, where our solutions are also available.
For purchase on the utility basis. So when you look at the consumption models that we've been able.
Both the technology and the commercial models that we've enabled significantly reduced or eliminated any friction associated with using a five in public clouds.
These are good example of that where customers by.
An agreement for for three years, and then they can deploy licenses in any environment, including in public clouds and port licenses from one public cloud to the other or one public cloud to back to on Prem.
So all of that leads to a growth in our cloud software revenue, which I've always said.
Last quarter or in the last six months of 2019.
We had growth in our software business of 90% for Q3 in Q4, but our club business had gone even faster than that.
And it continues to be on a very strong growth trend.
And Tim in relation to the service revenue, obviously, we're really pleased with having 8%.
Year over year growth in in Q1 that was obviously above what.
Good God into the last time, we talked about the service revenue components, which was the way back and aim of 2018, when we talked about.
Mid to low.
Growth during the horizon one timeframe. So this is a this is great performance to see what we're seeing actually is also an increasingly attach rates costs all the cohorts of age contracts and so it's not really from our perspective any decline in.
Hardware that is impacting over longer period of time decrease in the services revenue business. What it actually is is more of the mix of things that come through as.
Subscription were that subscription looks more like a SaaS subscription and a lot of that revenue gets recognized almost all that revenue gets recognized.
In the product side and not the services side and so.
We continue to see strong growth in the services revenue, probably even above where we thought when we thought about this in in March in 2018, but over a longer period of time, we do see those services revenues coming down in terms of growth rates, but that's really more of a mix issue than anything to do with.
A systems versus a software sale.
Okay. Thank you.
Your next question comes from James Fish with Piper Sandler Your line is open.
Hey, guys. Thanks for the question here, if I can squeeze into as well no enterprise still grew about 5% this quarter yet industry.
Everyone seeing that kind of straight yes can you guys. Just go into what's going on enterprise, specifically that is showing that resiliency. Thanks.
I I James stake Thanks for the question the.
Generally on the enterprise, we continue to see.
Pending patterns that are.
Relatively healthy.
In.
Others.
As they were in 2018, but we haven't seen a change.
Overall from the spending patterns that we saw in 2019.
So we see seem to continue on that trend.
Changes or variation bye bye.
By geography.
And as you know we pointed several times that we were seeing self testing in Europe and in the UK and back in particular and I think we continue to see that today.
But overall the spending patterns are.
Our healthy when you look by the way.
It sure Youre context is that of other.
Obstacle or is it infrastructure.
Data centers, what we're seeing more and more.
James is the spending with us.
Two applications.
The growth of application.
Not tied to data center infrastructure per se.
So perhaps over time, you'll see more and more of that that difference, but the spending patterns I relate to is what we see with our customers acquisition.
Got it and just a follow up on that I mean, it was a slight miss on what we were all expecting on products for the quarter were there any pause in orders ahead of the combined.
Controller.
And why do you expect audit tax software to accelerate next quarter.
James That's that's two separate question I will start with the first one on product revenue growth.
Product revenue growth was flat.
Indeed.
It could have been a little better than that.
What we saw in Q1 I think there were really a couple of factors in Q1 one is.
Go some lumpiness in some large deals.
That we expected.
In Q1, we also did.
Well typically important realignment of our North America.
Sales organization.
In part to prepare to better focus on certain verticals.
And to also involve the alignment of our team given the evolution that's going on in our portfolio with new SaaS solution engine ex come in and ship coming in.
And I think that.
Realignment.
The bit of a short term pause on momentum.
It's also for the better and we'll see the benefits of that.
For the rest of the year. So I think those were.
Two of the two of the factors specifically on product revenue growth. Your second question about.
Why we expect stronger revenue growth in Q2 for software specifically.
I think this issue of large deal Lumpiness does apply also two large software deals and we have a very robust pipeline of software deals going into into Q2, and so we're pretty confident that will feel very strong growth into two.
Thanks, guys.
Thank you Jim.
Your next question comes from.
With credit Suisse. Your line is open.
Hi, Thank you.
The touch up on a percentage of enterprise wins that are tied more to security use cases versus more of the legacy business. I guess, you could say more 80 see like.
Sales. So just trying to understand has the importance of security for your customers shifted even further to the forefront of their decision, making or would you say, it's very comparable how it was over the last year. So I understand there have been a big shift forward in terms of security use cases.
Hi, sorry.
Well, we don't.
You know today, we don't breakout.
Surety revenues.
Typically we continue to see.
Strong growth in our security business.
And I said before we see more growth in security business than the rest of the portfolio.
And so the answer to your question is yes, we continue to see more in.
Our.
Deals driven by security use cases.
In a lot of cases these deals also pool.
Other application services that you would classify more as application delivery services.
But increasingly in a meaningful portion of our business security is the use cases that actually pools Oh the deal together.
The second.
So that kind of accelerates.
That trend if you will is that in a multi cloud environments. We are seeing double the security attach rate.
12 solution, but we are seeing on prem and so given that more and more of our business is becoming.
Multi cloud in terms of the deployment we are seeing.
An increase of our of our security business and that all of that by the way, we expect to see that accelerate with shape.
In the synergies that we expect to drive between the shape portfolio and the the five portfolio.
Got it. Thank you and then I kind of just wanted to touch back onto the services growth rate that you saw in the quarter. Obviously, 8% is positive surprise for most people look at your model.
On a five three factors for what's driving that one of them wasn't new tools. So given that this just played out in this quarter should we expect similar high single digit growth or even in the same ballpark of growth and services for the rest of the year as these.
Three factors continue to drive the business forward to continue to drive more services renewals or should we expect like a moderation on the growth rate.
Jamie I think we gave some fairly specific.
Guidance for Q2 in particular that probably gets you to.
A number that Tim was getting too which is slightly down from where we where we printed Q1, but still very healthy in terms of a growth rate for Q2, as we look out over the course of the year that services growth rate may start to modulate down, particularly as we get more and more traction with with some.
The pure SaaS type.
Revenue models that we discussed, but I think it's safe to say that the overall services growth rate is going to be higher than probably what we thought about at the end of our horizon one guidance when we talked about this in March in 2018.
Got it thank you.
Your next question comes from Samik Chatterjee with JP Morgan Your line is open.
Hi, Thanks for taking the question funds. So if I can just start off well with Doe.
More longer term question, I mean, you've been making investments both organic as well as an organic since you kind of.
Took award and have been aligning the company growth areas No I do think about the transformation can you kind of.
Help us think work, which inning fuel and given that.
Thanks commensurate to pricing.
And it seemed to indicate you kind of done with most of the heavy lifting income so big transformation that you envision.
Thank you Saliq.
Yeah.
Well, let me start with.
What's driving this transformation we have a believe so it should look at.
You know.
Also versus other players in the industry.
We have a very strategic position in that we are in line of the traffic between application and users.
For a very very large number of applications.
And with the acquisition of engine X, we extended our reach very significantly.
And we're not part of the flow for several hundred million applications.
Our belief is simply driven by the fact that.
Number and complexities.
Applications in the future is going to increase.
An increase exponentially from what we are given everybody's transformations and as a result.
We have an opportunity to extend that strategic position to more applications and also clarify more applications more application services.
Applications and that's really what we have been doing with this transformation.
Our priority is to do it organically, but when in the selective scenarios, where we see an opportunity to accelerate that unification.
Within a window of time, we have decided to do that.
And you've seen two instances of that.
Where are we out in this transformation I would say we are in the early innings. Because we think we are actually in the very early innings of the digital transformation.
Of our customers. So I expect that the growth opportunity for a five as we succeed in.
Unified is application services for these new multi cloud environment.
Well ahead of us and it's very significant.
Got it.
People know for Frank Frank how should we think about the trajectory for Opex beyond Q seven I think you said 325 to 337, so beyond that how should we be thinking about the trajectory.
Yes, I think so I would just go back to what I said Korea. The shape acquisition in terms of Q2 is always our seasonable seasonal low point in the in the Opex cycle and we intend to tick up in Q3 in Q4.
In terms of operating margin expansion, we still there very comfortable with our guidance that we put out for the year of 30 to 32 for the year and so Directionally I think Q2 will be the low point and then move back up from there in Q3 Q4.
Great. Thank you thanks, Okay.
Your next question comes from Paul Silverstein with Cowen Your line is open.
Paul Silverstein your line is open.
Your next question comes from Rod Hall with Goldman Sachs. Your line is open.
Yes, Hi, guys I just wanted to ask a couple of things on the shape acquisition.
I think you guys called out these non-GAAP adjustments to revenue and I wanted to just come back to those that wasn't.
I'm not sure I fully understand now so maybe if you could go back into a little bit more detail on exactly what that is.
And then I wanted to also on shape just ask maybe you said this earlier, but what was the contribution or what is the contribution of shape to the guidance it seems like.
I think you guys had said there was an they are our 70 million growing at 50% and kind of if I do some rough math math on that I get to 5 million boxes, maybe revenue contribution maybe it's less than that maybe more of I just trying to get some idea of what's in the guidance from shape.
Thanks.
Sure Rod to we're not specifically actually breaking out guidance for shape. The reason why we did that with engine access because engine ex actually closed after we had given guidance and so when we reported engine X. We tried to be specific on what was.
The relationship are recognized revenue versus.
What we guided to and then the contribution from Enginetics that will shape, we've gone into with it and we're not breaking that out at this time.
In terms of what we said in what France want talked about when we actually announced the ship acquisition in the non-GAAP revenue.
With a SaaS based business model and you see this quite frequently in software.
Land, where.
Companies acquire with a companies with a very large deferred revenue balance.
Given the way revenue comes into those SaaS models, where there's a significant write down in that revenue as part of.
Purchase accounting and so to try to give the users of our financial statements.
Better sense for what the long term growth rate is going to be as opposed to a muted.
Revenue, we're going to be reporting both GAAP and non-GAAP revenue.
Give better comparability in years to come.
And for just one other thing to clarify you guys said the services would grow at about the same rates I guess like 6% and not including shape looks to me like it drops out about 260 million or product revenue in.
The guided quarter I mean, that's is that correct way to look at that.
That number isn't exactly what is familiar to me, but I think.
It's not so far off I think the.
Rate he had probably for Q4 last time was I think 6.6 0.56 to 6.5 to 6.3.
Yep.
So you're thinking almost exactly that growth rate.
Yes, okay.
Okay.
There is no services revenue for shape.
Right. Okay. Thank you Frank that that's helpful too thanks, yes.
Your next question comes from the had a gem with Cowen Your line is open.
Thank you for taking my question.
Turning to understand the odd to software.
Revenue trends in terms of your software revenue can you help us understand how much of it is requiring it how much is easily.
Jeff we really are split that out.
In the past.
In terms of is it reasonable to assume that majority of software revenue is still coming from E.L.A.'s.
The no it's not.
We take a look I think we talked about a few quarters ago, the pure percentage of recurring revenue of our total revenue.
With 60% plus and we continue to build and that's exactly what we saw.
In in Q1.
Okay.
And then if I may ask one more question.
Regarding the shape security.
If we assume that more almost all ships securities security revenue would you be breaking out your security revenue as a standalone now that chip is close.
We don't anticipate doing that at this time for hard, but you know we're talking about several different CPI metrics.
For aim in March and you know TBD on on what we decide there.
All right. Thank you for my questions.
Sure. Thanks, Matt.
Your next question comes from amid Daddy with Evercore. Your line is open.
Hi, Thank you for taking the question. This is lexie on for Ahmed So I guess, what we're wondering about is when we're looking at the 60% to 70% growth in software moving forward how much of that is organic versus M&A driven.
Then on the organic side, what are the top two or three contributors to that grows.
All right.
Let me, let me start with.
As you know, we're not breaking out.
You know.
Shape and Enginetics courses.
The business prior to ship and engineering, but let me give you some some indicators.
Last year, the five software.
Who about 60% year on year or there was a very small contribution of engine acts in the in the second half a year or two that growth.
We guided.
After the Enginetics acquisition to growth in software horizon, one which in 2020.
35% to 40%.
You can see we are well above that we were.
You know, 60% for the full year last year night sent into second half and we are 60%.
This quarter. So there's just gives you a sense that the growth.
In I'm going to call it five traditional software.
Prior to even Enginetics and shape is very significant and that's driven by a few things.
It's driven by.
The work that we've done on.
Making our software easier to consume in private clouds and automated environment is driven by the work that we've done in.
Our software in public clouds and is driven by the work we've done in enabling.
New consumption models, Yeley subscription and utility that's I try not environment.
And that's the.
Five is done but it's also.
As a primary driver coming from our customers desire to move from.
Sort of hardware first posture as to software Port first postures and seeing that change in our customers both in enterprise.
And in the service provider World by service providers start more and more virtualizing their structure. So they're very strong demand drivers from our customers to move to a software consumption of five.
When you look at 2020.
We do expect.
Contribution from from Enginetics and from shape.
To achieve or exceed our 60% to 70% guidance.
Actually the only thing I'd add is that we did say during the prepared remarks that even without shape, we did expect.
Q2 software growth to be above the 50% level that we experienced that you want.
Great. Thank you very much.
Thank you.
Your next question comes from Alex Henderson with Needham Your line is open.
Great. Thank you very much.
You're talking a little bit about the ingenico acquisition relative to.
Selling process and the new products that you're introducing here so I understand it the value of genex's predominantly in selling to.
Application coders.
People that.
Generally focused on an application specific project and have had little success selling the controller, because that's generally sold back too.
Net ops.
Administration.
Conversely.
Your historical footprint five is predominantly been selling into.
The net option.
But you Didnt have really good access to the to the coding community Dev ops community.
As you've introduced this.
3.0, and are now bringing that back through the five just distribution architecture.
Thank you then integrate that into a beacon and then have the full value of the controls.
Through.
And Genex controller too.
Centrally managed the people who are in the.
Net ops I spent the Dev ops slash coder community does that bring power back too.
The net ops people in a way that they've been losing in the past can you talk a little bit about that dynamic.
Yes, Thank you Alex.
Short answer to all this is yes.
But let me.
Let me give you a bit of context.
So if you look at.
Where enginetics had gotten traction in terms of revenue is really.
Offering.
There are data plane.
Above the open source capabilities into data plane offering additional features in the data plane and as well.
Support and that's really how enginetics so far in the in the current model had monetized.
Their technology.
The controller, all new dimension to that so the Dev off.
Immunity because number one it makes it a lot easier to deploy and manage.
Large scale implementations of engine exit of planes across a number of applications.
And so if you look at the folks who really to date have been able to use enginetics. It's folks who are very sophisticated dev ops people and have the skills and expertise to integrate these deployments and manage them on their own.
So with the controller. It offers essentially an easy button that allows a much larger group of people, but perhaps don't have the same sophistication to now use angiovac technology and use that technology on the large scale.
So that's kind of.
The first driver the controller also integrate application centric.
Im which really is targeted.
Moreover, the enterprise.
Users, including what we called Super Annette ups users in large enterprises and so it does it does give.
Ability for the net ops people to still have visibility of what goes on in the in the infrastructure under their applications and the Dev ops people to have a self service model to deploy their application faster and make changes or applications very quickly. So we at the time of the acquisition, we said that five an engineer.
Together, we're going to bridge to divide between Nettleton Dev ops and the controller really the manifestation of that strategy.
It's really the first.
Offer in the market that truly bridges, the divide and allow these two communities to work in concert serving the needs for speed of Dev ops, and serving the needs for visibility and compliance from the Nettops people.
This.
Controller will indeed.
Integrate in.
Article Beacon, which will give visibility and analytics.
Across all five environment Enginetics Big IP.
And.
And other environment. So that's the that's the convergence. We think this is a is a very important.
Launch.
For our engineers business because in addition to the capabilities around Dev ops and bridging the divide. It also does increase the deal size for Angiomax products, because it makes large scale deployment easier and offer new and exciting capabilities.
For a number of open source users that may want to move up a tier and use the control as a commercial technology.
Great. Thank you very much that's pretty clear.
Your next question comes from Simon Leopold with Raymond James Your line is open.
Hi, This is the Victor Chiu in for Simon Leopold can you just give us an update on where the telco stand regarding the shift to software.
Implementations are BDC and kind of the outlook there.
Hi, Simon.
There are continuing to see.
An acceleration in.
Telco starting to move.
Two virtualization.
We saw a couple of large deals again in that space this quarter with large service providers.
And this is driven by essentially readiness for for Fiveg.
And also the desire for service providers to be able to move faster when they need to make changes to their infrastructure and overall be able to reduce their their costs.
What we're seeing for now is service providers kind of keeping there.
More hardware based infrastructure in place and starting kind of Greenfield software implementations for four virtualization.
Over the long time I think these will converge, but for now goes we see in the service lighters that.
We work with we see these as two separate.
Diamonds for the time being overall the trend is accelerating.
That's helpful. Thank you.
Your final question comes from Jeff Kvaal with instead your line is open.
Just because all your line is open.
Your final question comes from that of Marshall with Morgan Stanley . Your line is open.
Looking at their I get to benefit from Jeff.
Quick question on the AAMC partnership just any update there that you could give and then I assume because youve revalidated, the 30% to 33% operating margin target, but just on the mid to high single digit dilution target and kind of breakeven on 24 month.
For ships security have any of those expectations change that's it thanks.
I mean, I just wanted to be clear when we talked about.
30% to 32% operating margin sorry, 30 to 32, yes, yes, just went through that were clear on the numbers. They go ahead, France was going to talk about need to be us.
Yes, Matt So we've made good progress.
On.
Execution of our roadmap with.
Ws on the strategic collaboration agreement.
We have been prioritizing the sort of highest impact opportunities.
Both teams are now working very well in the field, we're seeing a number of new opportunities surface that we didnt have access to a before and if you recall in in Q4, I said that that's what we expected in part because part of this agreement was that.
Number of Wi Fi solutions architects.
Who faced customers every day, we're going to be trained on a five solution and we expected them to bring opportunities. That's worth five that perhaps we would not have seen before and that's exactly what we have started to see so it's it's early days.
In the partnership.
And we said that I think he was expected it to really give us a meaningful results in the second half of 2020, but from what we're seeing so far.
We are we're pretty bullish about what we could accomplish together with it.
Great. Thanks.
Thank you Matt.
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