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spk09: Good afternoon and welcome to the F5 Network's first quarter fiscal 2021 financial results conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Also, today's conference is being recorded. If anyone has any objections, please disconnect at this time. I'll now turn the call over to Ms. Suzanne Dulong. Ma'am, you may begin.
spk05: Hello and welcome. I'm Suzanne Dulong, F5's Vice President of Investor Relations. Francois Locodinou, F5's President and CEO, and Frank Peltscher, F5's Executive Vice President and CFO, will be making prepared remarks on today's call. Other members of the F5 executive team are also on hand to answer questions during the Q&A session. A copy of today's press release is available on our website at F5.com, or an archived version of today's call will be available through April 27th, 2021. Today's live discussion is supported by slides, which are viewable on the webcast and will be posted to our IR site at the conclusion of today's discussion. The replay of today's call will be available through Midnight Pacific Time, January 27th, by dialing 800-585-7000. 8367 or 416-621-4642. Use meeting ID 605-5259. For additional information or follow-up questions, please reach out to me directly at s.dulong at f5.com. Our discussion today will contain forward-looking statements, which include words such as believe, anticipate, expect, and target. These forward-looking statements involve uncertainties and risks that may cause our actual results to differ materially from those expressed or implied by these statements. Factors that may affect our results are summarized in the press release announcing our financial results and described in detail in our SEC filings. Please note that F5 has no duty to update any information presented in this call. And with that, I'll turn the call over to Francois.
spk12: Thank you, Suzanne, and good afternoon, everyone. Thank you for joining us today. Our first quarter results show the strong momentum in our business. We delivered Q1 non-GAAP revenue of $626 million, representing revenue growth of 10%. We also delivered 70% non-GAAP software revenue growth, systems growth of 5%, and global services growth of 1%. Several quarters into the pandemic, several things are becoming clearer from a macro perspective. First, the realities of the pandemic have accelerated our customers' digital transformation and both business and consumer dependency on applications. At the same time, consumers' expectations about their application experience have increased significantly. As a result of higher volumes and higher consumer expectations, our customers are ramping their investments in their applications and the infrastructure needed to securely deliver them. In addition, incumbency is a significant advantage for F5 in the current environment. Customers want a trusted and operationalized partner they know they can count on. These micro drivers play to our strengths including our strategy to invest over the last several years in pursuit of our adaptive applications vision. Our continued investments in big IP for multi-cloud deployments and the deliberate and early investments in both NGINX and Shape are enabling us to rapidly grow our application security and delivery footprint in modern application environments. I will speak more to our business growth drivers and momentum including some customer highlights from the quarter after Franck reviews our first quarter financial results and our outlook for Q2. Franck?
spk11: Thank you, Francois, and good afternoon, everyone. As we previewed in our preliminary results announcement and as Francois just highlighted, we delivered a very strong Q1. On a GAAP basis, Q1 revenue was $625 million. First quarter non-GAAP revenue of $626 million was up 10% year-over-year and well above the high end of our initial $595 to $615 million guidance range. Please note, as I review our revenue mix, I will be referring to non-GAAP revenue measures. Also, this will be the last quarter we speak about non-GAAP revenue as we lap the acquisition of SHAPE. Going forward, the add-back of the SHAPE purchase accounting write-down is de minimis. Q1 product revenue of $289 million was up 23% year-over-year and accounted for approximately 46% of total revenue. This is the strongest product revenue growth we have delivered since Q2 of fiscal year 2011, nearly a decade ago. As Francois noted, customers accelerating their digital transformation efforts drove growth in both our software and system sales. Software revenue was $111 million, growing 70% compared to the year-ago period, which did not include contribution from Shape. Excluding Shape's contribution in Q1 of 21, software revenue grew approximately 35% year-over-year. Our mix shift continued this quarter, with software representing 38% of product revenue in Q1, up from 28% in the year-ago quarter. Customers' preference for flexible subscription models continued to fuel our subscription revenue momentum. In Q1, we again drove record subscription volume with subscriptions representing 77% of software revenue in the quarter. Services revenue of $337 million grew 1% year-over-year and represented 54% of revenue. Revenue from recurring sources, which includes term subscriptions, As a service and utility-based revenue, as well as the maintenance portion of our services revenue, totaled 66% of revenue in the quarter. This is up from 63% in the year-ago period. The improvement comes largely as a result of the strong subscription software momentum I mentioned previously. Systems revenue of $179 million was up 5% compared to last year, Francois will speak to the drivers of this strong performance in more detail. On a regional basis in Q1, Americas delivered 14% revenue growth year-over-year, representing 55% of total revenue. EMEA delivered 4% growth, representing 26% of revenue, while APAC grew 7% and accounted for 19% of revenue. Looking at our bookings by vertical, enterprise customers represented 67% of product bookings, service providers accounted for 14%, and government customers represented 18% of product bookings, including 6% from U.S. Federal. Let me now share our Q1 operating results. Gap gross margin in Q1 was 81.6%. Non-gap gross margin was 84.4%. GAAP operating expenses were 392 million. Non-GAAP operating expenses were 322 million. Our GAAP operating margin for Q1 was 18.9%, and our non-GAAP operating margin was 33%. Our GAAP effective tax rate for the quarter was 25.1%, and our non-GAAP effective tax rate was 21.7%. GAAP net income for the quarter was 88 million, or $1.41 per share. Non-GAAP net income was $161 million or $2.59 per share. I will now turn to the balance sheet. We generated $137 million in cash flow from operations in Q1. Cash and investments totaled approximately $1.5 billion at quarter end. We did not make any share repurchases in Q1. We remain committed to repurchasing $1 billion in shares over the next two years, including $500 million via an accelerated share repurchase program in fiscal year 2021. DSO was 50 days, and capital expenditures for the quarter were $5 million. Deferred revenue increased 10% year-over-year to $1.4 billion. we ended the quarter with approximately 6,160 employees, up approximately 50 from Q4. Now, let me share our guidance for our fiscal second quarter. Unless otherwise stated, please note that my guidance comments reference non-GAAP metrics. Also, with the Volterra deal recently closed, our Q2 outlook incorporates the addition of their financials to our guidance expectations. Near term, we expect customers will continue to invest to support application growth and the modernization of their application infrastructures. We also anticipate continued focus on an investment in application security. With this in mind, we are targeting Q2 fiscal year 2021 revenue in the range of $625 to $645 million, reflecting year-over-year growth of approximately 8.5% at the midpoint of our range. While we do not give quarterly guidance on product revenue mix, we do anticipate continued near-term strength in systems with Q2 growth likely similar to Q1. We would also remind you that our prior year Q2 software revenue growth was exceptionally strong at 96%. This difficult comparison is likely to be reflected in our Q2 21 software growth rate being below our Horizon 2 target of 35 to 40%. This is consistent with our commentary about the potential for quarterly variability in software growth rates as we continue to scale our software business. We expect Q221 gross margins of 84 to 84.5%, and we estimate operating expenses of $340 to $352 million. As we discussed last quarter, we generally see a seasonal increase in operating expenses in Q2. We expect our Q2 operating margin to decline from Q1 and then to increase in the back half of the year to achieve our FY21 non-GAAP operating margin target of 31 to 32%. I will remind you once more that our Q2 21 outlook also incorporates the addition of Volterra into our operating model. We anticipate our effective tax rate for Q2 will be in the range of 21 to 22%. Our Q2 earnings target is $2.32 to $2.44 per share. We expect Q2 share-based compensation expense of approximately $62 to $64 million. As for capital deployment, as I mentioned previously, we intend to repurchase 500 million shares via an accelerated share repurchase in fiscal 2021. With that, I will turn the call back over to Francois. Francois?
spk12: Thank you, Frank. Several quarters into the pandemic, it is growing clear that COVID has accelerated digital transformation and both business and consumer dependency on applications. As a result, our customers are accelerating their digital transformation investments. Incumbency is also an advantage for us in the current environment. And together, these trends are enabling us to drive strong growth. Underneath these micro drivers, and consistent with our discussion at our November analyst and investor meeting, there are three S5 specific growth drivers fueling our demand. One. ongoing software and subscription momentum, two, growing demand for application security, and three, resiliency in systems-based demand leading to moderating systems revenue declines. As we noted in November, these multiple growth drivers mean that we also have multiple paths to achieve our Horizon 2 revenue growth targets. More specifically, we do not need everything to go exactly right to achieve our goals. In Q1, we had a lot go right, and customer demand drove growth across all three of these drivers. I will speak to each in turn. First, we continue to see demand for software and subscription consumption across our application security and delivery solutions. I will focus first on our BIG-IP and NGINX solutions. Customers look to BIG-IP to refresh core business applications for capacity additions and to simplify traditional application delivery in cloud environments. In one example during Q1, a large financial institution struggled for months to turn up a mission-critical application in a cloud environment. This was despite the best efforts of the cloud provider they were working with. Frustrated, they turned to F5. In under one day, we help them get the app up and running in the cloud with multiple BIG-IP virtual editions. This use case highlights the customer benefits we have driven as a result of our investment to modernize BIG-IP, making it easier and more efficient to use in cloud environments. Let me turn to NGINX. At the time of the NGINX acquisition, we deliberately invested in new products, accelerating time to market. Specifically, we built a joint F5 NGINX controller and rapidly ported F5 security to the NGINX platform. This quarter, NGINX delivered its largest quarter ever with broad-based strength across geographies. This strength was driven in large part by robust NGINX controller traction as well as integrated F5 security through NGINX App Protect. During Q1, we also secured a win for BIG-IP, Controller, NGINX Plus, and NGINX App Protect with a longtime F5 federal government customer. While upgrading its current BIG-IP infrastructure, this customer also selected NGINX to help prepare for migrating network infrastructure from physical to virtual while building out capabilities to support containerization. NGINX is leading the way in a number of modern application use cases, including cloud-native load balancing, scaling APIs, and delivering Kubernetes applications in production. As applications continue to get more distributed, we expect the investments we are making to deliver API gateway, API management, and service mesh capabilities will drive additional NGINX momentum. It should come as no surprise that customer demand for application security is also growing. With the ongoing pandemic fueling ever-increasing consumer use of digital channels, the threat landscape is growing significantly. With application-based attacks growing both in numbers and sophistication, customers are looking to F5 for help. The combination of our organic investment and the addition of shape has created an enhanced F5 application security portfolio. If you map our solution set against the top application security threats, it is clear that we are very well positioned to help our customers address the most frequent incidents and the most damaging breaches. We continue to see increased interest in adding F5 enterprise-grade web application firewall protection to modern applications. During Q1, a major car manufacturer selected NGINX with AppProtect when they needed a cloud-independent, portable, scalable solution that included a container-friendly web application firewall. We also are seeing growing traction for SSL orchestration. This end-quick, de-quick use case is a strategic differentiator for F5. And while it tends not to be a big revenue driver on its own, it is a strategic control point in enterprise customers' security stack, which gives us the ability to pull in big IP security and shape. Let me speak also to the traction we are seeing with shape, and in particular, our shape-server-line combination. Last quarter, We highlighted the benefit of making Shape's industry-leading anti-fraud solution available to a much larger customer base through our SilverLine managed services platform. SilverLine Shape Defense delivers advanced bot protection to prevent large-scale fraud. Shape AI Fraud Engine, or SAFE, is a cloud fraud prevention service. As a combined solution, our Silverline-shaped defense and safe solutions enable sparsely resourced organizations to deploy true industry-leading capabilities. Combining Shape's anti-bot and anti-fraud capabilities with Silverline, a managed service, also makes it easy to quickly deploy Shape's capability, which is especially useful when customers are in crisis. There are two interesting use cases that have emerged. First, Shape Silver Line Defense is being used by several US states to combat rampant fraud related to unemployment benefits. The combination of sky-high demand and limited security of fraud capabilities created an ideal environment for fraudsters for conducting sophisticated attacks against unemployment sites, as well as other unprotected state domains. With a Shaped Solar Line Defense solution, we can go in and offer real data about what is happening, unveiling the true scale of the threat. Once enabled, Shaped's sophisticated AI and machine learning capabilities identify and block the fraudsters. Credit unions also are emerging as an ideal use case for shaped silver line defense. With new web and mobile banking capabilities coming online and larger transfer limits being introduced, credit unions can present an easy target for sophisticated attackers. Pressure to provide the same services as big banks is exposing them and their lack of cybersecurity and fraud capabilities. Shape Silver Line Defense provides an affordable, turnkey, easy-to-deploy managed security and fraud solution as evidenced by the five credit union wins our sales team delivered in Q1 2021. We are as excited as ever about the use cases Shape has opened for us. Going forward, we see additional potential to leverage Shapes Analytics Engine to build new analytics offerings that enable us to go beyond application security to drive revenue enhancement for customers. Finally, let us talk about systems and the drivers for the growth we saw in Q1. First, I will note that our systems business is also benefiting from the macro trends I mentioned previously, namely COVID driving increased application use and accelerating investment in digital transformation. Q1's strength in systems was broad-based across geographies and industries. We identified three primary factors behind our strong systems performance. First, as we have discussed previously, we have seen growing demand for systems-based security use cases. Second, over the last several years, customers have gained clarity on their cloud strategies and now expect to operate in a hybrid multi-cloud world for some time to come. As a result, they are more willing to purchase systems to support capacity needs driven by accelerating digital transformation. We believe both of these drivers are sustainable. Third, Q1 also benefited from some COVID-suppressed systems catch-up. Customers who have put off systems purchases for several quarters simply can no longer defer growing capacity demands. For a very small subset of our customers that had not refreshed in a long time, a long-planned April end of software development milestone on one of our legacy systems contributed to their desire to act sooner rather than later. For clarity, I would note that end of software development is very different than end of support. In this case, the April milestone pertains to an end of software development date that has been well-publicized for years, providing customers a long planning runway. We estimate this catch-up demand drove approximately $10 million in system sales in Q1. We see this as a transient systems growth driver but we do expect it to carry over into Q2. Finally, while I did not call it out as a growth driver, our expanded reach and role has also expanded our strategic position with customers. This has enhanced our ability to connect with C-level personas and also means we are more often considered for opportunities that span our application security and delivery portfolio, bridging traditional and modern applications in both hardware and software form factors. As an example, in Q1, one of the United States' leading healthcare providers selected BIG-IP hardware, software, security, and NGINX to keep their critical care applications running non-stop while beginning to migrate to next-generation apps for their care providers. This project re-emerged as a priority for the customer after being deferred last February so the customer could divert all necessary resources despite COVID. In closing, We are encouraged by our momentum and believe we are seeing clear signs that our organic investments and our value creation methodology for both NGINX and SHIB are paying off for customers and investors alike. We were very pleased to announce that our acquisition of Volterra closed yesterday and the team has already begun the hard work of integration. Initial customer feedback about the combination of S5 and Volterra has been very positive. Customers are excited about the potential of F5's Edge 2.0 to eliminate the pain they feel from today's closed Edge platforms. Our Edge 2.0 will be the first Edge platform built for enterprises and service providers. It will be an open Edge platform that will allow every service to run on any server, virtual or otherwise, inclusive of public clouds. We are very excited to have the Volterra team as part of F5 and are looking forward to sharing our progress with you going forward. I will wrap up today's prepared remarks by thanking the entire F5 team again, as well as our customers and our partners. With that, operator, we will now open the call to Q&A.
spk09: As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound or hash key. Please stand by while we compile the Q&A roster. Your first question comes from Sammy Badri from Credit Suisse. Please go ahead.
spk10: Great. Thank you. And congratulations on the solid quarter and highlighting some of these major trends and drivers that we're seeing in your business. So, Francois, I want to go back to almost about a year ago when the pandemic first started. And you called out all these, you know, you called out pros and cons of the pandemic, some deals being pushed out, some deals being reaccelerated back. Some of the catch-up demand that you saw at Fiscal 1Q and the catch-up or potential pull forward, or sorry, however you want to put it, recapped above demand at Fiscal 2Q 2021. Are you basically seeing all the deals that were punted about a year ago or through 2020 are all essentially coming back to full force, at least within 2021?
spk12: Hey, Sami, thanks for the question. The short answer is no. On what we call the catch-up demand, there are some customers, and I would say there are a small subset of customers who have waited and waited and waited on adding capacity, in part because of the uncertainty related of COVID or the absence of resources or the ability to physically do it. who are now doing those refresh. But it isn't, if you go back to the deals that were pushed out at the beginning of the pandemic, there were some software deals, we call them software transformation deals that were pushed out. And we're starting to see these come back, but not yet in a big way. So I think that's still ahead of us.
spk10: Got it, got it. My other question is to do with systems revenue. And I know we had the analyst day relatively recently where you did guide a little bit differently to systems versus what you're guiding today and reported to Q1Q and then guiding to Q2Q with a 5% growth. Now, based on some of the underlying industry drivers that you highlighted and some of the customers that have identified F5 gear as like the go-to gear for security measures, does your overall analyst day guide boosts for negative growth of systems in fiscal year 2021 and for Horizon 2? Does that kind of now go away and we're looking at a little bit of a different trajectory?
spk12: Well, Sami, I think we've got to go back and look at the drivers of our hardware business. So I think if you look at where we're at today, Sami, there are two kind of macro things. that are benefiting the company in general. Generally, there's more spending on applications infrastructure, and we have positioned ourselves to benefit from that, and I think that's a long-term effect. There's also the effect of the company is strategically better positioned because of the combination of hardware and software and cloud solutions and security solutions that we have. And that allows us to have more strategic conversations with our customers and being seen as a future-proof partner for the strategic plans. And all of that benefits all of our business, including our systems business. If you look at the drivers specifically to our systems business, there are two drivers that I think are long-term and one that is more of a transient driver. So if you look specifically on the long-term, we talked about at Analyst Day that our mix of security had grown and that was helping our systems business. And this quarter, we saw again, you know, stronger growth in security than in the overall demand. So that helps the systems business. The second factor in our systems business is that generally we have some customers who, if you recall, we talked about that two, three years ago, customers who basically have said they were either going all in on the cloud or they were essentially pausing the systems business to reconsider their architecture for public cloud deployment. And I think a lot of customers we're seeing have kind of graduated from that and now have a clear strategy around the cloud They have maturity around knowing that they're going to operate in hybrid cloud environments for a long time to come. And they're very comfortable moving forward with hardware as part of their long-term architecture. And so we're seeing some customers that have decided not to buy any more hardware at all, but are coming back and now refreshing or adding capacity to their systems. So I think those two aspects are longer-term savvy. There is one transient driver, which is a subset of our customers that really had to make a refresh because of this end of software development. We think that was about $10 million in the quarter. We think that kind of carries on in Q2. But that's a really short-term demand. So when you take all of that into account, we're not changing our Horizon 2 guidance. But yes, there is the possibility that our hardware business will do better in Horizon 2 than what we saw at AIM. We certainly think that for FY21, it's likely to do better than what we had in our overall Horizon 2 guidance.
spk10: Got it. Got it. Thank you. Congrats again on the quarter and the dynamics. And I'll pass it over to the next question.
spk09: Thank you. Your next question comes from Alex Henderson from Needham.
spk13: I was hoping you could talk a little bit about what you think the impact might have been from the solar wind pack and to what extent your software, your your cloud capabilities are seeing an acceleration in demand. If you've heard from any of your CIOs, CPOs, CFOs, CEO contacts or even board contacts, whether companies are increasing their spend on IT or specifically security as a result and to what extent you think that will translate to F5 demand.
spk12: Alex, you're asking if they're increasing spend on cloud and security as a result of what?
spk13: The SolarWinds hack.
spk12: Ah, okay. Not necessarily directly, Alex. There is, of course, heightened awareness of it generally by CISO and security organizations. Our security trends have been pretty strong over the last several quarters. The aspects that have accelerated security for us relate more to A, more customers moving to software and attaching more security use cases as they move to software. Same happening when they move to the public cloud, attaching more security in public cloud environments. And then with the addition of shape, what we have seen, frankly, since the pandemic started, what we're still seeing today is, you know, as more and more businesses go to digital channels, that also attracts more fraud. And so our offers for anti-fraud are seeing very strong demand. I mentioned a couple of use cases in my prepared remarks, but that is across the board. Large and small companies, there is more online fraud, and we're very well positioned to protect against that.
spk13: If I could follow up. So clearly you guys are seeing an increased correlation between your appliance sales and your software sales. suggesting that's from hybrid cloud. But hybrid cloud has been in place for quite a while. Is it also possible that the launch of the beacon product and the integration of NGINX back into the appliances accelerate and expand your ability to tie together the enterprise IT spending for campus and data center with the cloud integration? and therefore pulling both as a result.
spk12: Alex, yes, there is definitely an element of the overall portfolio creating stronger demand for F5. Beacon is still early days, but certainly with NGINX, um there is a significant factor and we're seeing it here um is the you know the halo effect of our participation in modern application uh we are you know what what's happening alex is um A lot of times we think about traditional and modern applications in kind of separate silos, but the reality for large enterprises is they do a lot of application modernization. That is, they will have a traditional application that is typically supported by big IT, As they modernize that application, they don't refactor it, but they add modern components to that application. These new modern components, typically microservices, NGINX is ideally suited to support these modern components. And so we're seeing that the combination of NGINX and BIG-IP gives a full solution set for these modernization initiatives that customers have. And it's pulling both NGINX and BIG-IP together. So there's definitely an effect of the portfolio and the synergies coming together and driving growth. Great. Thank you very much.
spk13: I appreciate the answer.
spk09: Your next question comes from the line of Tim Long from Barclays. Please go ahead.
spk03: Thank you. Two quick ones, if I could. First, could you guys talk a little bit about the organic software revenue growth line, Frank, understanding the tough compare, but maybe just talk a little bit about how we should look at that line in the future. Are we going to see it being a little bit less lumpy, particularly as We've seen deferred revenue really grow pretty strongly. So is that something you expect to normalize around a higher number as we get through some of the tougher compares? And then second, I think at your analyst day or somewhere around there, you talked about $100 million cloud revenue. Could you just give us a little color in the quarter, whether it's qualitative or quantitative, around how the cloud-specific software businesses did for F5? Thank you.
spk11: Yeah, Tim, it's Frank. Let me start with the first part, and then I'll turn it over to Francois for the second. In terms of the organic growth in the quarter, we talked about 35%. And in the second quarter, we talked about that being 50%. likely lower than that 35% to 40% range that we've given you for Horizon 2, based off the telecom that's coming up at 96% in Q2 of 2020. And as the business continues to scale and as we get more of it from recurring subscriptions, we do expect to have some more normalization in that and not necessarily see the same swings. As we talked about, you know, from the beginning when we discussed software revenue, gosh, almost three years ago now, we said that it will be lumpy for this time as we continue to build up scale in the model. But overall, we are not changing at all. We're rising to outlook of a compounded annual growth rate of 35 to 40 percent. Francois, you want to add anything on the cloud side?
spk12: Yes, on the Cloud side, so Tim, we have very strong demand in the Cloud. The growth in public Cloud was actually stronger than the organic software growth rate that you saw, and that has been the case for the last number of quarters. And just generally, Tim, to the demand of software, yeah, we will see still some variability, but the overall demand drivers for software are very strong. And I'll point to a couple. We had an all-time high number of multi-year subscription agreements in the quarter. A lot of these subscription agreements include multiple software solutions from F5, including NGINX. NGINX had the best quarter ever. And we're really seeing as customers start to really deploy these modern applications, NGINX growing very fast. We also made some investments, as you know, in NGINX a year ago in the controller and app security, and we're seeing the effect of those in terms of growing the size of deals that we have and the addressable deals that we can bring to the table. And so when you factor that cloud, the number of subscription agreements, NGINX, and some new catalysts that haven't played out yet, you know, we have some catalysts around the true forward in our subscriptions, you know, some new use cases for shape that are coming. So we feel, you know, very good about our software for Horizon 2.
spk03: Okay, thank you.
spk12: Thank you, Tim.
spk09: Your next question comes from Paul Silverstein from Cowan. Please go ahead.
spk08: Appreciate it. Before I ask my questions, I was hoping I could ask Frank to just clarify two pedestrian issues. One, Frank, is my math right that shape did roughly $22 million in the quarter in your comment about organic in total growth for software?
spk11: Paul, actually, it was higher than that, bud. So it's We didn't give the exact number, but it's higher than that. There was some slight growth over what we experienced in Q4.
spk08: Eric Green I suspect I know the answer to this question, but we'll ask. Francois, you made the statement multiple times that you had the best record in Gen X quarter, which means you clearly know what the specific Gen X revenue was. Is that a number you're willing to share with us? I hope the answer is yes.
spk12: no we haven't uh you know broken out uh nginx lately but it's uh you know you saw the numbers uh paul that we shared at our analysts and investor day around the doubling of revenue of nginx and the growth in in deal size and essentially this trend is continuing or accelerating i should say yeah i know i get it but okay i'm not sure
spk08: You want credit for it, but you don't want to give us the details.
spk00: But I'll move along.
spk08: Let me ask you the real questions. Operating leverage. You've been very clear that you're going to drive operating leverage this year, next year, and beyond. I assume it's as simple as you guys are planning to grow OpEx slower than revenue, which obviously that's the math. But the question really is, it's within your control. Since there's variance in revenue growth, up or down relative to your horizon to fiscal 21 22 outlook i see are you planning to adjust office accordingly or will you you know which leads does revenue lead or does opex lead yeah paul so what we what we've talked about is you know the 31 to 32 percent and that's what we are targeting um if we find opportunities for investment to continue to drive that
spk11: revenue growth, we will make those investments. Having said that, we are committed to that 31 to 32% in FY21 and the overall horizontal two outlook that we gave you as well as the long-term model. And so that's the way we are managing the business. We are very excited to see the 10% growth this quarter and the 8.5% for next quarter implied in the midpoint of our guidance range. And those are both obviously above the Horizon 2 outlook and, you know, the factors that go into the rule of 40. We ended up at 43 this quarter. And so we're really happy with that continued progress. But that rule of 40 is the North Star that we continue to strive for within the business.
spk08: All right. I trust from your comments and Francois' comments that visibility today is better than than it was 90 days ago, 365 days ago. But let me ask you the opening question. What is visibility today versus previous years? Has it improved or has it just remained solid?
spk11: And I'm assuming you mean visibility in the pipeline and sales opportunities is the primary factor here.
spk08: Forward-looking metrics, correct.
spk11: Yep. Visibility continues to grow and be strong for us following work. excited about the outlook that we've given you.
spk08: All right. I'll pass it on. Appreciate it.
spk09: Your next question comes from the line of Maida Marshall from Morgan Stanley. Please go ahead. Maida Marshall, your line is open.
spk06: Apologies. This might be circling around some of the other questions that were asked, but you noted a couple of quarters ago that people were kind of heads down amidst COVID and that if they were buying physical editions before, they continued to buy physical editions. If they were buying virtual, they continued. You spoke, Francois, about people kind of having a little bit more of a framework of what their hybrid architectures were. look like. But I guess I'm just trying to get a sense of, is there still a contingent of customers who are just kind of heads down and just trying to address the problems with their current architectures? And that could be kind of lifting systems revenue for now. And then just maybe some of the puts and takes on the lumpiness in the service provider revenue and just understanding some of that is project-based, but just maybe that tracking a little bit under traditional kind of percentage of revenue would be helpful. Thanks.
spk12: Hi, Neda. Let me start with the service provider. You know, our bookings on demand in service provider were up year on year. And, you know, we continue to see a strong demand in, you know, 4G solution. We're seeing start of some capacity increases related to 5G, but, you know, we think the bigger kind of demand in 5G is probably still six to 12 months away. But generally, so the trends in our service provider business has kind of continued as stable. as it relates to customers in the enterprise and whether some of them are still uh not moving forward with some projects um yes that is still the case um what we're seeing meta is um our incumbency in a number of customers and the fact that we're operationalized whether we're operationalizing hardware or in software uh is actually a significant uh advantage because we still see a lot of customers that continue to do incremental things and we'll come back to bigger transformational projects later And, yes, in some ways, because with a number of customers, hardware is still a majority of our business, that does favor our hardware business in a way more than our software business.
spk06: Great. Thanks.
spk09: Your next question comes from the line of Rod Hall from Goldman Sachs. Please go ahead.
spk04: I wanted to see if you guys could give us some indication of what you're thinking for services growth in Q2. And then I have a follow up on that.
spk11: Yeah, we didn't split it out specifically, Rod. I think, you know, it's going to be in those low single digits. My guess is it's higher than the 1% that you saw this quarter. But I'm not expecting it to be in the mid-single digits.
spk04: So like 2% or 3%, Frank, something like that?
spk11: Okay.
spk04: And then I wanted to come back and just clarify what you guys said in response to Paul on the organic software. Maybe I guess the more direct question is what the Volterra contribution would be in Q2. Can you give us any idea on that?
spk11: It's de minimis. You know, we talked about less than – less than 10 million for the full year when we discuss the announce the opposition. And so it's going to be, you know, diminished throughout. It's not a number that we're going to split out.
spk04: okay um and then finally just another clarification this 10 million dollars that you guys talked about in in q1 and then i think frank said or francois you said it carried into um q2 but it wasn't clear are you saying 10 million dollars again in q2 or i would assume some number less than that but can you clarify what that you know what that number should look like in q2 roughly for us yeah rod it's
spk11: know it was about five big points um you know in the in the quarter um and it may be something similar to that there's obviously a declining revenue stream between uh q1 and q2 for systems on the product side and so uh it it's hard to say exactly but it probably is a little less than 10 but i wouldn't say it's dramatically less than 10.
spk04: And then, Frank, that falls to zero after Q2, right? So it's just a Q1, Q2 phenomenon, you think?
spk11: I'm not giving guidance beyond that, Bud, but, you know, the date that we had given out was April 21, two or three years ago. And so it could, you know, stretch beyond that. Some customers, this is, you know, a generation – a two or three generation old product, and so I don't know exactly when people are going to go through that upgrade cycle, but our guess is it's done mostly by next quarter. Thank you, James.
spk04: James Fishman Okay, great. Thanks very much. Appreciate it.
spk09: Your next question comes from James Fish from Piper Sandler. Please go ahead.
spk07: James Fishman Hey, guys. Thanks for the question. A little bit on the guide and the results here. You know, you said it wasn't budget flush a few weeks ago and talked about project deferral and increased app infrastructure investment. I guess, could you in any way break out how much of it was project deferral from product quarters coming into the quarter here versus kind of increased activity and pipe around that app infrastructure investment versus, frankly, share gains?
spk12: Well, hi, James. Look, I think the major drivers here are more around increased investments in application infrastructure driven by an acceleration of digital transformation and digital channels for all companies that is floating to application infrastructure and capacity additions. I think that's, I would say, kind of factor number one. I think our improved strategic position with customers and the fact that they are more comfortable moving forward with a hardware purchase with F5, knowing that we are also their partner for software, that we're now also their partner for modern applications, that we're also their partner for public cloud deployments, and they don't see F5 as a single-threaded platform. if you will, that's just a hardware partner, that is also, you know, providing an opportunity for, you know, opportunities to move forward, even in hardware. I would see those are the two major factors. The catch-ups is just for some customers that have just, you know, tried to wait out, if you will, the pandemic to do some refresh. You know, some of them are moving forward, but I would say that's, less of a factor than the first two.
spk07: That's helpful, Francois. Last one for me, going off of Rod's question. Obviously, it was announced a couple of years ago. Just making sure we should think about it as $10 million for fiscal Q2, or could it be more? And really, my question is, are there other systems over the next 12 to 18 months that are on a similar path that we should be reminded of?
spk12: Yeah, so fiscal Q2, James, you should think of it as $10 million or less. So we think it will be less than what it was this quarter, as Frank said, but exactly where can't pin it. And then to your point around other systems that were maybe the same situation, there isn't any similar effect in the next 18 months.
spk07: Thank you. Congrats, guys. Thank you, James.
spk09: Your next question comes from Jason Ader from William Blair. Please go ahead.
spk02: Thank you. Guys, I'm just curious, would you say it's possible that the growth outlook for your ADC business has actually hit an inflection point?
spk12: Well, yes. I mean, I think as we discussed earlier, whilst we are not changing our overall view for Horizon 2 of an overall growth of 7-8%. If you look at the recent trends, it's possible that we're going to see on our systems business a better trend than what we anticipated in our Horizon 2 guidance. Now, I will remind you that when we laid out our Horizon 2 guidance and the drivers of growth for F5 that are driving the 7% to 8% growth, there were three substantial drivers. The first one is continued momentum in software and software subscriptions. And we are continuing, I mean, we posted 70% growth year on year this quarter. And we're going to continue to see very strong growth in software because the flywheel of subscriptions that we've put in motion now two and a half years ago is really working well for us as a motion and for our customers. The second driver is demand for application security, and we're seeing that also being very strong, boosted by the addition of shape and the use cases that I've talked about. And then the third driver was a moderation in our systems declines, and we had said at the time it would moderate from double-digit to high to mid-single-digit decline. Now, we felt when we put the guidance together that not all three of these things had to go perfectly for us to achieve the 7% to 8%. And so we have multiple paths of getting there. And right now, you know, in this first quarter, essentially, you know, all three are pretty much going very well. So if that continues, there's a possibility we do better than what we thought. And right now, specifically in hardware, you know, the trends are pretty strong.
spk02: Can you remind us, what was the kind of organic growth trend excluding the three acquisitions. What were you telling us on what that would grow in Horizon 2?
spk12: The growth for Horizon 2 was 35% to 40% for all software. And the only component of that, pre-Volterra, of course, that was organic, was just one quarter of Shake, which was the quarter we just had, the first quarter. Everything else was organic.
spk02: Okay. So I guess what I was asking is the kind of the non-EngineX kind of ADC business, that was going to be, you know, flat to slightly up. I mean, could the outlook for that be more something like mid-single-digit growth going forward?
spk12: Yeah, we don't break that out. The answer is no, it wasn't going to be flat. It was going to grow much faster than that. But we don't break out specifically the software growth percentage of big IP versus NGINX. Frankly, increasingly, as I showed earlier, those solutions are actually used in the same subscription agreement to support customers that have traditional and modern applications that need to scale. And so they have become increasingly synergistic and kind of driving growth for one another. But the software growth number that we shared, including Big IP, NGINX, Shape, as part of our security portfolio. Okay. Thank you. Thank you.
spk09: Your next question comes from Simic Chatterjee from J.P. Morgan. Please go ahead.
spk01: Hi. Thanks for taking my question and squeezing me in here. I guess, Francois, from what I hear right up to your comments here, it does sound more like what you're saying is you didn't really need software systems and services to fire on all cylinders, but given where you are today in the first half, you would exceed the 7% to 8% horizon to revenue growth target this year if things continue this way. And so I just wanted to confirm that's what you're implying. And then if you can help me think about sustainability of that higher than kind of 7% to 8% growth rate into next year, given the momentum that you're seeing in the business. And I have a follow-up.
spk12: Thank you. Sanik, I think just to be clear, you know, we're not changing our guidance for Horizon 2 of 7% to 8%. That remains our view on Horizon 2. If we're speaking specifically about FY21, If you look clearly in the first half, our expectation, if you look at the midpoint of guidance for Q2, is we will exceed the 7% to 8% just on the basis of the first half. And frankly, if the trends that we're seeing right now were to continue, there's a possibility we could exceed that as well for FY21, but we're not here guiding for FY21. If you're asking about the underlying drivers that I see in the business for growth, I think the drivers we're seeing for both software and security are very strong and very sustainable. And in hardware, some of the drivers we're seeing that I've talked to are actually sustainable. There is a change there that we're seeing in how customers are approaching deployment of traditional applications in this hybrid cloud environment. And the place that they're giving F5 in their go forward plans and the strategic position we occupy now, I think that is sustainable. There are a couple of things that I think are transient that are not. And so how much of that will play out in terms of FY22 and beyond, it's really too early to say that now.
spk01: Thanks for that. And a quick follow-up here for Frank. Frank, I'm calculating about a 25 million OPEX increase from 1Q to 2Q. Can you clarify how much of that is from Volterra?
spk11: Yeah, I'm not splitting it out specifically, Bud, but I would say it's in the sort of single-digit millions. So I would say mid-single-digit millions would be probably more accurate. But that's something that we're not going to expect to sort of split out going forward. It's just too de minimis in terms of the total number. Okay. Great. Thank you.
spk00: Thanks for the questions.
spk12: Yep. Thank you, Samir.
spk09: We'll take our last question today from Amit Daryanati from Evercore.
spk12: Thanks a lot for literally squeezing me in, guys. I guess maybe just from the system side, I know it's been discussed a bit, but given everything you've talked about, which is not all the stuff that was held up last year is back yet, and I would imagine that perhaps the share game narrative that hasn't been talked about could be somewhat powerful as well. Could we see a scenario where that systems business actually accelerates in the back end of the year? And if not, I guess what are the caveats to that statement? I mean, I didn't catch the last part of your question. The first part is, could the systems business accelerate? What was the second part? Yeah, if I think about all the stuff that was held up last year that still has to come back into the funnel, plus the share gain potential you could have in terms of just picking up a little bit more share, I would imagine that systems business could accelerate as it goes through fiscal 21. And so I'm curious, what would be the caveat or the reservation from that dynamic? Well, it's a good question. Look, the way I would think about this is if you look at the kind of long-term trends for F5 and where we're going to be as a company in the long term, and we have said for the long term with the acquisition of Volterra now, we expect to grow double digit in the long term. uh that's going to be driven by software software subscription and fast we don't expect our hardware business to be a growth business um you know it going into the future um so that that's that's our view of things um and there there's nothing that has happened in the last uh you know three months that would make us fundamentally change uh that view of the long term Now, you know, in the short term, will it accelerate beyond what we're seeing in the second half of 2021? You know, that's unlikely, but we're not going to rule it out given the dynamics that we're seeing with our customers today. And if I could just clarify this, the model for the deceleration that you're talking about in the software business, in march which is which is december is that just a reflection of you compared to very difficult in the march quarter or is there something else you call out that driving that modest fuel again nope that's what that's what we called out and that's our feeling it's just a much harder comp that we that we had in uh in q1 And it's a harder comp, because as a reminder, we had last two, I think, growth rate was 95% or 96% year on year. So you have a harder comp. But the underlying dynamics and drivers for software demand are very strong across NGINX, shape, subscription agreements, and the momentum we're seeing there. um and uh and general security so that that that we are very confident that is going to continue to pick up perfect that's it for me thank you very much thank you that concludes our call today thank you for joining you may now disconnect
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