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Edited Transcript of CTXS earnings conference call or presentation 24-Jul-19 8:45pm GMT

Q2 2019 Citrix Systems Inc Earnings Call

FORT LAUDERDALE Jul 26, 2019 (Thomson StreetEvents) -- Edited Transcript of Citrix Systems Inc earnings conference call or presentation Wednesday, July 24, 2019 at 8:45:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David James Henshall

Citrix Systems, Inc. - CEO, President & Director

* Traci T. Tsuchiguchi

Citrix Systems, Inc. - VP of IR

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Conference Call Participants

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* Brad Robert Reback

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst

* Daniel Robert Bergstrom

RBC Capital Markets, LLC, Research Division - Analyst

* Heather Anne Bellini

Goldman Sachs Group Inc., Research Division - MD & Analyst

* John Stephen DiFucci

Jefferies LLC, Research Division - Equity Analyst

* Karl Emil Keirstead

Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst

* Keith Weiss

Morgan Stanley, Research Division - Equity Analyst

* Mark L. Moerdler

Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst

* Peter Marc Levine

Evercore ISI Institutional Equities, Research Division - Analyst

* Philip Alan Winslow

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Raimo Lenschow

Barclays Bank PLC, Research Division - MD & Analyst

* Sanjit Kumar Singh

Morgan Stanley, Research Division - VP

* Sui Ying Cheong

BofA Merrill Lynch, Research Division - Analyst

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Presentation

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Operator [1]

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Good afternoon. My name is Ashley, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Citrix Systems Second Quarter 2019 Earnings Conference Call. (Operator Instructions) Thank you. I would now like to introduce Ms. Tsuchiguchi, Vice President of Investor Relations. You may begin your conference.

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Traci T. Tsuchiguchi, Citrix Systems, Inc. - VP of IR [2]

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Thank you, Ashley. Good afternoon, everyone, and thank you for joining us for today's second quarter and fiscal year 2019 earnings call. Participating on the call will be David Henshall, President and Chief Executive Officer; and Jessica Soisson, interim Chief Financial Officer. Please note that we have posted our second quarter earnings letter to our Investor Relations website.

I'd like to remind you that today's conversation will contain forward-looking statements made under the safe harbor provision of the U.S. securities law. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially from those anticipated. Additional information concerning these and other factors is highlighted in today's earnings letter and in the company's filings with the SEC. Copies are available from the SEC or on our Investor Relations website.

Furthermore, we will discuss various non-GAAP financial measures as defined by SEC's Regulation G. A reconciliation of the differences between GAAP and non-GAAP financial measures discussed on today's call can be found at the end of our earnings letter found on the Investor Relations page of our website.

Now I'd like to turn it over to David, our President and Chief Executive Officer. David?

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [3]

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Thanks, Traci, and good afternoon. Thanks to everybody for joining the call. I hope everybody had an opportunity to review the earnings letter that we posted to our IR site. Similar to last quarter, I'm going to keep my opening remarks really brief so we can jump right into Q&A, but I thought it'd be important to provide a little bit of context on the business overall.

So I think all in, I'm really happy with our performance in the second quarter. Demand across our products and our geos was remarkably consistent throughout the quarter. The only real difference was mix. We clearly underestimated the demand for subscription licensing in the quarter. The subscription transition for new licensing is really happening faster than we forecasted across both of our major businesses, which is strategically where we're driving the company.

We expected this accelerated pace to really continue for the full year. The obvious consequence here of the faster shift is that revenue, margins, earnings and cash flow are going to be impacted in the short term, with the offset represented in unbilled and deferred revenue in particular.

Just to be really clear here. So the mix shift explains the entire difference between our reported second quarter results and our guidance. We had guided a midpoint mix of about 52%, and the actual was 62%. Within this result, we also saw record subscription booking levels in both of our businesses. The Workspace product mix jumped up to 71% from 58% a year ago, while Networking moved from 11% last year up to 35% in Q2. And I can talk much more about the demand drivers once we get into Q&A.

It's important to point out again that for all of our financial statements are going to be impacted by the business transition, including cash flow because we typically bill annually for subscription contracts rather than everything upfront like we typically do in a perpetual license deal. So less cash is collected in the current period, more cash is going to be collected in future periods. So in other words, the strength that we're seeing in subscription bookings serve to improve our predictability and certainly accelerate our growth in future period. That's the primary reason why we've introduced future committed revenues, one of our new metrics. Hopefully, you saw that, that balance is now up to $2.2 billion. It's up $290 million or 15% from last year. It's really the easiest way to think about the transition.

But to make the full year transition math really simple for everybody, let me just give you a quick rule of thumb. That is for every 1 percentage point change in mix, it's equal to roughly $10 million to $12 million in recognized revenue for a full year basis. This offset to the decrease in recognized revenue in the period is generally the corresponding increase to unbilled or deferred revenue. So that when you look at our full year guidance, we now expect a subscription mix of new product bookings of at least 60% to 65%. This compared to 50%, 55% earlier. This is a change from our prior guidance to our current guidance.

Finally, this quarter, we are introducing ARR, or annualized recurring revenue, as probably the most important KPI for our business. The way we've calculated this is a bottoms-up, contract-based metrics, which we believe is really the most important way to measure the performance of this transition. You'll see a 5-quarter history in our earnings letter. And I'll point out, for Q2, total subscription ARR was $614 million, and that's up 33% year-on-year. While the SaaS-only ARR was $418 million, and that's up nearly 50% year-over-year. As we continue to move through the business model transformation, we expect to see very strong continued growth in both of these metrics.

So let me stop there with that and turn it back over to the operator so that we can open it up and take your questions. Ashley?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Raimo Lenschow with Barclays.

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Raimo Lenschow, Barclays Bank PLC, Research Division - MD & Analyst [2]

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I know there's a lot of stuff to go through, David, like can you help us a little bit to understand, like, what do you see in terms of customers in terms of term and Citrix service provider versus like doing this as a SaaS offering in terms of like what do you see there? Because if I look at the numbers on my side, it seemed more CSP and term was driving it, but I'm just trying to understand the dynamic there.

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [3]

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Yes. I'd say only 2 things, Raimo. I mean, we're seeing strong growth across all 3 of those areas. You saw that SaaS-only ARR is the one that really ticked up. It's growing nearly 50% right now at a scale north of $400 million. So that is the -- probably the cleanest representation of thinking about Citrix Cloud. The other 2 businesses that show up and the other subscription you pointed out, CSP, which for everybody is the consumption-based subscription that we have mostly through our partners, that business is north of $100 million run rate now, continues to grow nicely.

And then on-premise term. And I'd say on-premise term is a bridge for a lot of customers as they're moving from a perpetual license to a true subscription. A lot of those tend to be hybrid licenses, where they're working through the transition of their own infrastructure. Long term, we actually want to highlight much more SaaS-driven. And so on-prem term is -- I look at that as a bit of a bridge in between the 2, but the fastest-growing part of the business is pure SaaS.

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Operator [4]

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And our next question comes from the line of Phil Winslow with Wells Fargo.

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Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [5]

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I actually just have 2 of them. First, David, if I look at Workspace Services, obviously, you highlighted the continued consumption subscription there. But on a reported basis, you're still up by I think 7% year-over-year. Wondering if you can just walk us through some of the demand drivers that you've been seeing in the first half because, obviously, this first half here has been into acceleration like apples-to-apples growth. And then just one follow-up to that.

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [6]

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Sure, Phil. I'm actually really excited about the Workspace right now. Like you've said, we've seen really solid growth in this business on a recognized basis, even though 71% of the mix last quarter came via subscription. And that's -- like hold those numbers. Those are new product mix and so there's 2 things going on. I mean we have been leading the market for years around desktop and app virtualization, just pure virtualization. And I think that part of the overall business has seen a nice resurgence in the last couple of years because customers are really focused on mobility and security and those types of opportunities.

But really, what's most important for us and probably most exciting is the message that we're driving with customers right now about the intelligent Workspace and how we can move those capabilities not just for those users that are focused on virtualization, but really add value to everybody inside the enterprise. And we introduced a number of those capabilities in -- at our Synergy Conference a couple of months ago. We'll be shipping those in the back half of the year. So I think our message is resonating, and it'll allow us over a long period of time to really expand our available TAM, drive incremental penetration within our installed base and also look for net new customers that really are not using any form of virtualization. So that's where we're taking the product line. That one is clearly leading the subscription transition, and I would expect it to be close to 80% by the end of the year.

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Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [7]

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Got it. And then just as a follow-up. As you mentioned, Synergy, obviously there was some significant announcements with Microsoft out of Synergy, including Brad Anderson kind of unofficially announcing the renewal of that partnership. Can you just give us an update on just the partnership with Microsoft, particularly the new products that are coming up?

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [8]

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Yes. I'd say only the partnership is strong as it's been in 20 years, and that's for a couple of reasons. One, we have really good alignment in the field. We're working with customers. A lot of customers are going through major projects like O 365, Azure transformations, lots of bigger projects. And we've -- we can joint sell with Microsoft and really help support a lot of those capabilities, and so that's been very positive. In the longer term, it's a huge opportunity for customers to continue to move their Citrix workflows onto Azure or one of the other major cloud properties, and that's why we work so well with them.

Specific to your question about individual products. Yes, Brad was with us at Synergy, and we announced a number of new things. For example, the support of their new platform, which they call Windows Virtual Desktop. Now we've integrated that with Citrix Cloud so that customers can look at that at as one more place to run their workloads, giving them really unprecedented flexibility across Citrix Cloud.

We also announced the Citrix Managed Desktops, which is really a DaaS service sitting on top of that platform. And we're doing that with Microsoft, and we'll be able to bundle Azure capacity and really create a clean turnkey.

We also announced a number of other areas, and I'm sure I'm going to forget all of them, but optimizations for Windows -- excuse me, for Office 365, for SD-WAN. We can do a lot of really cool things to accelerate the performance of Office, HDX optimizations for Teams, SD-WAN more broadly for Windows Virtual Desktop, adding performance and resiliency as well as a number of other areas. So I'd say the partnership is as broad as it's certainly been in any time in my 17 years.

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Operator [9]

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Our next question comes from the line of Karl Keirstead with Deutsche Bank.

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Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [10]

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David, I just want to get to the question of, call it, normalized revenue growth. So you posted 1% growth, but you mentioned that there was a 600 to 700 basis point headwind from the mix so, call it, normalized 7%, 8% growth. I think when you gave guidance 3 months ago for roughly 3% to 4% growth in 2Q, you were calling for a 200 to 300 basis point hit from the bookings mix, which would equate to normalized growth of like 6%, 7%. So my simple math suggests that you were in line or slightly above your prior guide on a normalized basis. I just wanted to check that math and assess whether it's directionally accurate anyway.

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [11]

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Karl, I think your math is exactly right. If you look at the mix shift, I mean, it's basically just our prior expectations and the actuals. It's mixed. There's really nothing more to that.

Just step back and think about normalized growth rates. I mean what we've been executing on, if you normalize this whole push to subscription -- or if you normalize the growth in unbilled revenue so you can really have apples-to-apples, you look at businesses or companies as a whole that's operating in that mid- to high single-digit range, and that's effectively where we'd be operating on a pure steady-state basis. I think as everybody knows, of course, we're driving this transition to create much more incremental value long term for customers or stickiness from a product value standpoint. Obviously, that translates into higher returns for investors.

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Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [12]

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Got it. Okay. And then maybe a second question. Just on 3Q, your expectation for the subscription bookings mix of 60% to 65% is pretty well in line with what you did in 2Q and yet the revenue guidance is for a 3% decline rather than 1% growth. So your revenue growth decels in 3Q, but your subscription bookings mix is quite similar. Maybe it's a complicated answer. I don't know. But why is that, Dave?

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [13]

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Yes. So (inaudible) the answer is there's always some seasonality in Q3. Not a whole lot more besides that. And then the mix of 60% to 65%, not sure exactly where it's going to fall in that range. But I think the rule of thumb that I laid out is a good way for everyone to think about it. If you remember when we went into Q2, we had guided a midpoint of at 52%, 52.5% mix, our revenue outlook would be x. We came in 10 points higher than that and so that influenced revenue. I think as we go forward, if our mix is a little hotter, that's where we'll come in closer at the bottom of our range and vice versa.

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Karl Emil Keirstead, Deutsche Bank AG, Research Division - Director and Senior Equity Research Analyst [14]

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Okay. And if no one would get too upset if I ask a third, and I promise I'll stop there, without stealing the thunder from your September 9 Analyst Day where I'm guessing you'll sort of lay out the transition -- the model transition impact on the financials over maybe 2020, 2021, Dave, is there any framework you can give us perhaps now on the call about sort of how long these pressures on revs, EPS, cash flow will last? Is it the kind of thing where things should begin to normalize, call it, second half 2020? Any broad framework ahead of the Analyst Day?

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [15]

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Yes. Let me talk about it at a high level. You're right. We do need to talk about those things in the context of a longer discussion. So I think as everybody knows, each year we update long-term targets as we've been moving through this transition, and that's based on actual results, customer feedback and the outlook. And we're going to do that again this year at our Analyst Meeting in a couple of months. But let's take a bit of a step back for a minute.

So we're 2 years into this transition. I think we made really good progress all in. But unlike other model transitions that we've seen across the industry, we've never really seen any material impact on the P&L up to this point. I think that's been for 2 reasons. First is that we've just had better internal execution and a really good product story so we've sold more. We've sold more and we've just been trying to balance the impact up to that point. And so Phase 1 has been focused really on net new, largely due to capacity and focus. And so last year, we moved about 42% of the net new mix to subscription. This year, as I said, we're looking at 60%, 65%. So that's a big increase. The numbers are now large enough that it's creating this headwind that you're seeing over the course of Q2 and the balance of this year really in the reported P&L. Again, like I mentioned a minute ago, the offset is going to show up in deferred and unbilled, plus these new metrics. So everybody has complete visibility.

The way I'm thinking about the next couple of years, though, is Phase 2 is going to bring much more focus on transitioning our really big installed base. So we've started that this year. We've seen a nice uplift in kind of the annualized dollars that those customers are paying for those we've transitioned so far, and so this is a big incremental opportunity. That's hundreds of millions of dollars annually. That's going to start to become a priority in 2020, and that's why to help everybody understand this, we've delivered these new metrics, unbilled revenue, ARR, in particular, so that everybody can really just see how that -- it impacts beyond reported P&L.

So we'll talk about all that in -- at our next Analyst Meeting, make sure that you have complete perspective. Again, we're providing the metrics so you can measure us along the way, look much more like a traditional subscription transition and looking forward to having that in-depth conversation.

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Operator [16]

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And our next question comes from the line of Heather Bellini with Goldman Sachs.

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Heather Anne Bellini, Goldman Sachs Group Inc., Research Division - MD & Analyst [17]

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Just a couple questions left here. Just on the point that you just mentioned in terms of Phase 2 of the transition of the installed base, any comments you could mention about churn thus far as you've been seeing those big customers transition and kind of what the level of uplift is that you're getting on pricing for those that are staying and kind of what the price realization is?

And then I just wanted to follow up because I know Phil asked a question about Microsoft. My question is just more related to Windows 10. There's been some people wondering how much of a driver that's been to the whole Workspace services improvements. And how does that filling -- the migration from Windows 7 to Windows 10, which has to be done by mid-January, does that become a headwind when you start to think about calendar '20 top line?

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [18]

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Yes. Let me talk about the second question first. I don't hear that much about Win 10 as a stand-alone driver. I think desktop no less isn't the driver that it would've been for a major project like it was a decade ago.

I'd say it's one of the many projects that customers are looking at, and it's one of the things that we can engage in. I'd say that more broadly speaking, when we're talking to customers today, and every customer meeting I had throughout Q2, was focused, I'd say, first on security, on how they're looking at managing an increasingly complex infrastructure.

Second, on mobility around just finally enabling devices to be used in the enterprise in a secure, simple way across what is usually hundreds of applications in most enterprises.

And then lastly, this idea that's a little bit more about our road map and our vision about really embracing employee productivity and driving engagement, things that will just make them -- their teams more productive. And so I'd say that's probably the bigger driver than any one-off like a Win 10 migration.

Back to the other question about the installed base. Yes, it's been -- we've actually seen really good success with those customers that we've updated so far. I'd say it's a limited set. So I wouldn't read too far into it, but the average uplift that we saw in Q2 was like 40% from what they had been paying on a typical maintenance contract. And again, that's because it's not just a like-for-like, but this whole migration opportunity is about moving them from what might have been a virtual app sale to a more broad Workspace sale. And so we'll get that uplift as we do that, but it also provides that platform for us to start expanding more horizontally into untapped seats inside that customer. So it's really a dual strategy. So we're really happy with what we're seeing so far. And we just have to scale that up. And it's one of the reasons why we've unified our renewal promotions globally now. We have introduced a new COO into the company, an existing employee, and help focus on really driving this Phase 2 in the next couple of years.

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Operator [19]

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And our next question comes from the line of Mark Moerdler with Bernstein Research.

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Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [20]

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I really appreciate the fact that you guys are giving more color and the ARR numbers and the breakdown of it is going to be helpful as well as the additional color in the filing. Two questions for you. I apologize there are 2, but the first question is while subscription bookings as a percentage of total product bookings were 62% in the quarter, can you give us some color on the percentage of the installed base that is through the subscription? Can you give a little color? Is there a better sense of what percentage of the base really has moved? Or are we really in a point at which the subscription to Citrix Cloud is really all from net new? Then I have a follow-up.

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [21]

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So your first question, Mark, it's -- I mean it's largely net new. We've -- we're looking at less than -- I'd say less than 10% of the installed base has moved at this point in time.

One important point to point out is that we are still selling perpetual licenses and so the installed base, as you define it, is still moving. It's still growing so it's not static necessarily. But that said, I'd say it's less than 10% at this point. And that's been intentional. I mean -- and we wanted to make sure that we get this whole process moving around and focused around net new and I think that's important. And once we have that going, and you've seen this really driving the business over the last couple of years, this gives us a much better framework to go and drive installed base. And I also think it's also given us an opportunity to really make sure the product sets across Citrix Cloud, across intelligent Workspace and all these new initiatives so that it's not just a migrate-to-cloud story, it's a much broader opportunity to talk about employee productivity and ways that we can help really drive what, in marketing terms, we call the future of work but a holistic strategy for customers.

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Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [22]

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I really appreciate it. And then as a follow-up, while Citrix Cloud is cloud, how should we think about the impact on gross margin? Is this more like a subscription where the margin impact is very low? Or is this more like a SaaS? How should we think about it?

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [23]

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I'd say it's a good question, Mark. I mean at a high level, our services are not necessarily compute or data-intensive. Therefore, at scale, we can manage with pretty high gross margins. That said, as we -- before we get to scale and we're bringing on more and more customers, I think there's a little bit of upfront there. There's probably a 50 basis point headwind in the first half of the year on gross margins. Not big, but it's there. And we obviously have teams that are focused on not just cloud COGS and optimizing that, but all of the aspects of cloud operations. And so there'll be some pressure on gross margins over the years, but we'll manage that. Our services are built out with full multi-tenancy and the things you would imagine, and so we'll be optimizing across the board.

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Mark L. Moerdler, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [24]

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Perfect. I apologize. I never do this, but I got one quick. Can you give a little more color on the NetScaler move to subscription and what the drivers are, what the lift is like? Any more data would be appreciated. (inaudible) is really focused at this point on that.

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [25]

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No. That's okay, Mark. It's actually a really interesting dynamic that's happening right now. I'd say I think as everybody would understand, there are secular changes going on in Networking in general, really driven by the adoption of cloud more than anything else. And so what we've seen over the last few quarters is a more pronounced move to software versus hardware, and that's simply because customers are looking for more flexibility, more choices in the way that they deploy their capabilities.

And the good news for Citrix, in particular, is that we're a software company and we can deploy our networking hardware on a physical appliance, in a virtual container, in a docker container as a service and a number of other things, and that's what gives customers flexibility. So the dynamic we're seeing right now is that customers that maybe in the past would have thought about a hardware refresh cycle, now they're looking at it as, why don't I do a software refresh cycle where I can buy, in our licensing terms, a pooled capacity license that could be shared across an on-premise infrastructure, any form of hybrid in a cloud, in a container, et cetera. We've got this great control plane that allows you to help manage that in a reasonably seamless way. So it just gives customers a lot more flexibility. That's something that we've got as pretty unique capabilities, and we're pushing that in the market fairly aggressively, and customers are responding. I think 35% of the mix in one quarter is a little higher than I would have expected. That's up from just over 10 a year ago, but that's a trend I expect to continue.

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Operator [26]

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And our next question comes from the line of Matt Hedberg with RBC Capital Markets.

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Daniel Robert Bergstrom, RBC Capital Markets, LLC, Research Division - Analyst [27]

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It's Dan Bergstrom for Matt Hedberg. So the acceleration in subscriptions is very impressive. You've pointed out some drivers such as hybrid, multi-cloud, Citrix Cloud in your investor letter and prepared remarks here, but could you pinpoint further the change in pace here versus last quarter? It's really dramatic.

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [28]

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Yes, it is. It's -- we did -- Q1, we were at 50% of the mix. Q2, we're at 62%. And I think in the second half of the year, we're going to be pushing 65% or higher to get to that full year of 60%, 65%. So I mean we're moving at a pretty rapid pace right now. As I pointed out, you can see in our letter, 71% of Workspace mix is now coming via subscription. That was up about 10 points from Q1 and 15 points or so year-on-year. That business will continue to move up. Obviously, the gains will start to slow down on an incremental mix basis because it's so rich. And then Networking, as it's moved up much more materially from 10% a year ago to 35% now, that's the biggest change.

We will still continue to sell a fair bit of hardware so I do not expect that in the next 12 months, let's say, to get north of 50%. But I think the rate that we're at right now is probably a pretty good floor, and it'll move up from here. And it's a function of 2 things. I think we have tried as a company to balance the transition, actively balance that over the last 6, 8 quarters while giving customers the choice that they want. Now we're just letting it -- embracing it and letting it happen at a bit more of a natural pace, and so you'll see it continue the way it was in Q2 into the back half of the year.

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Operator [29]

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And our next question comes from the line of Keith Weiss with Morgan Stanley.

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Sanjit Kumar Singh, Morgan Stanley, Research Division - VP [30]

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This is Sanjit Singh in for Keith Weiss. Maybe to start off in terms of managing the Phase 2 of the transition, from an operating margin perspective, is the view that you would just sort of let the transition happen as rapidly as possible, take the headwinds on margins upfront and kind of move, accelerate through the transition to get to a better margin profile down the road? Or is the view that you'll continue to protect margins as you execute your Phase 2?

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [31]

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Well, I think as you see the impact on the top line and certainly the overall growth, I mean, that will flow all the way through the P&L. I mean we saw that in Q2 and in our guidance for the second half of the year. I think we've moved margins up a lot in the last couple of years, and so we're not going to do anything artificial. We're investing to drive and grow the business and drive the transition. We're, of course, always thoughtful in how we manage our expenses and our head count growth and those types of things because we want to make sure we're investing in the right areas. But we absolutely have a view on how are we going to drive long-term sustainable growth. And so I wouldn't expect anything artificial from us in that regard.

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Keith Weiss, Morgan Stanley, Research Division - Equity Analyst [32]

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Got it. And for the follow-up, in terms of the new metrics that you released this quarter on paid subscriber count. It sounds like we're at 5.4 million today. If I understood you correctly, that's mostly net new. As we think about the maintenance base transitioning over to cloud, what do you think that number goes to? What do you think is sort of the number of available subscriber count that you have to transition? Is that 5.4 million? Does that increase significantly over the next upgrades? Any idea of where that number could go?

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [33]

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That could go much, much higher. I mean we're certainly not going to guide that one yet because that's predicated on a few different movements. But if you think about our installed base right now, I mean, it is tens and tens of millions of active users, and so the opportunity pool is very material. I think it's premature for us to try and put a number on that right now, but I think we're at the very front end of the broader opportunity.

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Operator [34]

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And our next question comes from the line of Nikolay Beliov with Bank of America Merrill Lynch.

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Sui Ying Cheong, BofA Merrill Lynch, Research Division - Analyst [35]

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This is actually Jacqueline on for Nikolay. So 2 questions. First, can you please give us some concrete examples of how Workspace will coexist with Windows Virtual Desktop and any areas of current or potential overlap? And my second question is what needs to happen from a product pricing or go-to-market perspective for the installed base to begin to move to the cloud?

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [36]

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So there's a couple of questions in there. I mean if you're coming back to the Microsoft-specific question, think about Windows Virtual Desktop as a platform, very similar to the way people have thought about Remote Desktop Services over the years, which was part of Windows Server. I think that's the easiest way to conceptualize it. And so as a platform, it's a multiuser version of Win 10. And so for a lot of our customers, they look at that as maybe a use case that makes sense in part of their business alongside everything else they're trying to accomplish. Our average customer is delivering over 500 applications across all different app types. And so for us to be able to open up Windows Virtual Desktop is another resource zone or another type of capability that could be managed inside of Citrix Cloud very similar to the way you would be managing, for example, an on-premise application or maybe a published SaaS application. So for a lot of customers, it just provides more flexibility.

From a platform standpoint, Citrix building a DaaS service on top of that really just embraces and extends a lot of the capabilities to be much more feature-rich on the enterprise side. So those are -- that's probably the easiest way to think about that. It's a component of a broader infrastructure from a typical Citrix customer standpoint. And can you repeat the question about go-to-market?

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Sui Ying Cheong, BofA Merrill Lynch, Research Division - Analyst [37]

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Yes. Just curious on what needs to happen from a product or pricing or go-to-market perspective for the installed base to begin to move to the cloud.

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [38]

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Well, I'd say, for the most part, the product is there. It's just -- and the pricing is there, and it's just a matter of focus from our point of view. We have different sense of that really from a compensation standpoint, not intentionally. I've talked about that each quarter because Teams only have so much bandwidth and we want to have the focus on net new in order to really start building the base. There's a big opportunity around the installed base, and so we'll start expanding that and really leveraging the success we've had in some of the early areas. So I think it's just about making sure we have enough capacity to serve customers, and that's why we've been investing in quota-carrying folks for the last couple of years as well as customer success. And then we'll tweak compensation along the way to make sure we're incenting the right outcomes as we go into 2020 and beyond.

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Operator [39]

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Our next question comes from the line of John DiFucci with Jefferies.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [40]

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David, I have 7 questions. Actually, I only have one. Listen, we understand the mix change and its effect on the financials. That all makes sense. But deferred revenue was also lower than expected, and I would have expected that, that would've been much better given the outsized ratable bookings. So can you explain that?

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [41]

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Yes. Two things on deferred. One, you have a -- we had a really big -- if you look back, a really big seasonal comp because we did a megadeal in Q2 a year ago, and that was a large net 8-figure deal. That's one thing. So that's the seasonal play.

The other is most of your growth is coming in unbilled right now instead of deferred because the contracts are moving to SaaS. And SaaS are 3-year deals on average, 1-year billed upfront. And that's why we didn't have unbilled a year ago, and now it's $380 million I think. And so that's the primary offset.

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John Stephen DiFucci, Jefferies LLC, Research Division - Equity Analyst [42]

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But I would think that the 1 year that you do bill upfront would be more than -- well, I guess, it'd be more than the maintenance that you'd bill, and that would go in deferred. I just -- it's still -- okay, I'm sorry. You said there are 2 things. Did you say both of them?

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [43]

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No. I'd point you back to ARR as well. And the reason we did that on a contractual basis: a, it's the rates are adjusted; and b, it just gives you the best end-of-quarter visibility into what's really going on. We're going to continue to deliver that on both a total subscription basis and a SaaS basis. And so I'd point you back there. But all in, deferred and unbilled were up 15% year-on-year, and I'm happy with that. I think they'll continue to grow in the future.

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Operator [44]

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Our next question comes from the line of Brad Reback with Stifel.

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Brad Robert Reback, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [45]

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David, with the headwinds from the subscription going forward here, does it impact your ability to return capital to shareholders? And if it does, to what effect?

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [46]

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No. Not materially. I think that when we look at how we have thought about capital return over the years, we've been really consistent. I mean we're always focused, first and foremost, on things that will grow the company, great M&A at the right price, and that's a priority. And when we find those, we execute on that. We also return excess capital via dividends, via share repurchase and that's -- I'm not sure that that's going to change in the future.

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Operator [47]

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Our next question comes from the line of Kirk Materne with Evercore.

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Peter Marc Levine, Evercore ISI Institutional Equities, Research Division - Analyst [48]

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Great. It's Peter Levine in for Kirk. Just 2 quick ones. Sorry if I missed it earlier, but can you give an update on the CFO search? And then second, just to piggyback off of the mix shift in the quarter, you talked about it, but just anything that you would call out in the sales or maybe the partner side that accelerated this quarter that's -- like kind of major change to guidance there?

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [49]

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Yes. Let me take the second part first. I'd say that with the benefit of hindsight, we've probably been holding it back a little bit in prior quarters in what was the normal customer motion, and so we're just letting it happen much more naturally. And I think that's representative of what you're seeing right now. And given the scale of the business, it's time to really lean in and embrace the transition and drive it more aggressively than we have been. So I'd say that that's easiest way to think about that and why we want to drive this expectation over the balance of the year, start looking a little bit more like a typical subscription transition that people are used to seeing across companies.

On the CFO search, it's going well. We've met with a number of external candidates. We have some great internal candidates as well, and we're just going through the process very methodically. We've got such a solid team right now that I feel comfortable where we are, but I'm more focused on making the right decision than making a quick decision. That said, hopefully, we get this wrapped up fairly quickly.

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Operator [50]

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And it looks like our next question is a follow-up from the line of Phil Winslow with Wells Fargo.

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Philip Alan Winslow, Wells Fargo Securities, LLC, Research Division - Senior Analyst [51]

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Actually, it's 2 follow-ups. David, obviously you mentioned some of the changes in just the market when it comes to the Networking business. With the subscriptions and some those changes and just sort of how NetScaler is being delivered, how should we think about the revenue breakeven from the old, call it, product/license model plus maintenance to subscription? And then also how should we think about sort of just the gross margin differential?

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [52]

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Yes, Philip. Gross margin is going to be higher because we're selling software that looks more like a typical software gross margin than a hardware gross margin. So the change is probably got a higher gross margin dollars. From a revenue standpoint, you're not selling the box along with it so you may have a little bit of a revenue headwind in the short term. But getting customers to build this out from a software standpoint as part of their infrastructure I think is going to drive really good stickiness. So I have to go back and look at it on a -- just probably a little bit more case-by-case than in the aggregate, but I'd say that the breakeven from gross margin and really the extension of gross margin dollars is relatively short term.

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Operator [53]

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Thank you. Ladies and gentlemen, we have reached the end of the allotted time for questions and answers. I will now turn the call back over to David for any closing remarks.

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David James Henshall, Citrix Systems, Inc. - CEO, President & Director [54]

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So thank you, everybody. Again, I appreciate all the multipart questions along the way. I just want to reiterate a couple of things as we go through this.

We're driving the business towards a subscription model probably faster than we would've anticipated over the course of the last several quarters. I mean Q2 is a great example of that performance shift relative to guidance, and that's why we updated the back half of the year.

We're delivering all these incremental metrics to make sure that you can look at the business holistically, whether that's ARR, with subscription ARR up 33% and SaaS ARR up nearly 50%. So that will be the most important way to lead the business on a go-forward basis.

Hopefully, everybody can join us at our upcoming Analyst Meeting in the next couple of months. Look forward to seeing you there. And if not, talk to you again in 3 months. Thank you.

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Operator [55]

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Thank you for participating in today's Citrix conference call. You may now disconnect.