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spk01: Good afternoon and welcome to the F5 Incorporated first quarter fiscal 2022 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 cell phone. Also, today's conference is being recorded. If anyone has an objection, please disconnect at this time. I'm now turning it over to Ms. Suzanne Dulong. Ma'am, you may begin.
spk07: Hello and welcome. I'm Suzanne Dulong, F5's Vice President on Investor Relations. Francois Le Cotonou, F5's President and CEO, and Frank Peltzer, 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 sessions. A copy of today's press release is available on our website at F5.com, where an archived version of today's call will be available through April 26, 2022. 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. To access the replay of today's call by phone, dial 800-585-8367 or 416-7000. and use Meeting ID 6879935. The telephonic replay will be available through midnight Pacific time, January 26, 2022. For additional information or follow-up questions, please reach out to me directly at s.dulong.fi.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. With that, I will turn the call over to Francois.
spk05: Thank you, Suzanne, and hello, everyone. Thank you for joining us today. Our strong first quarter results demonstrate our customers' need to grow and evolve the applications that support and drive their businesses. Customer demands stand our portfolio, driving 10% revenue growth in Q1 and our fifth consecutive quarter of double-digit revenue growth. Underpinning our top-line growth is robust 47% software growth one percent systems growth and two percent global services growth in the quarter in fact both software and systems demand exceeded our expectations in q1 contributing to our out performance we are at the epicenter of digital transformation and application security we are differentiated by our focus expertise and the vision and technology assets to secure and deliver any application anywhere as a result we have seen strengthening demand across our software portfolio and persistent strong demand for our system. Like others in the industry, since late 2020, we have been taking progressively more aggressive steps to manage supply chain risk. These include pre-ordering components, investing to secure supply, qualifying and sourcing alternate components, and purchasing on the open market to fill gaps that arise. Over the last year, stronger than expected demand for systems, coupled with ongoing supply chain constraints, have gated our systems revenue growth. As a result of persistent strong systems demand, our systems backlog continues to grow in Q1. Over the last 30 days, suppliers of critical components that spend a number of our platforms have informed us of significant increases in decommits. These came in the form of both order delivery delays and sudden and pronounced reduction in shipment quantities. The step function decline in component availability is significantly restricting our ability to meet our customers' continued strong demand for our systems. The challenge is acute in Q2, and we expect Q2 revenue in the range of $610 to $650 million as a result. This revenue range reflects a $60 to $80 million shortfall in our ability to ship in our second quarter versus what we would have expected absent these recent supply chains and strengths. Based on the information we have today, we estimate that increased supply chain limitations are likely to have a net $30 to $90 million impact to our prior revenue guidance for fiscal year 2022. We are aggressively working to mitigate the impact of two primary gating supply challenges near-term. First, like others in the industry, we are seeing worsening availability of specialized networking chipsets. Within the last 30 days, we have learned that deliveries for 52-week lead time components ordered a year ago have been pushed out and that our expected quantities have been reduced. Second, we also have experienced significant recommits for standard semiconductor components. We are working to design and qualify replacement components to resolve these standard component challenges. While we are unlikely to be able to do so in time to mitigate production shortfalls in Q2, we expect that we can mitigate the impact on the second half of our fiscal year. In addition to continuing to work with our suppliers, our sales teams also will be working with customers to fulfill their demand with alternative offerings. In some cases, customers may be able to qualify and ship demand to recently introduced platforms that are less affected by supply chain issues because they use more readily available components. Now, let me be very clear. The main drivers across our business are stronger than they have ever been. While near-term supply chain challenges may disrupt our revenue growth trajectory short-term, fundamentally, they do not change the significant opportunity we have to solve our customers' most critical application security and delivery challenges. Nor do they change our longer-term growth potential. Our software transition continues to gain momentum, In fact, we now expect to be closer to the top end of our 35% to 40% stockholder revenue growth range for the year. In addition, systems demand exceeded our plan in Q1 and remained strong headed into Q2. Because of the strong demand signals we see and our confidence in our longer-term trajectory, we will continue to invest responsibly in our business and will not make any dramatic changes to our operating model short-term. While this will mean near-term pressure on our operating margin, it best positions us to continue to capture our growth opportunity and long-term earnings potential. We expect to return to our previously forecasted operating margin profile as we return to full manufacturing capacity. Our Q1 customer wins offer great insight to both our momentum and the opportunity ahead. For instance, pervasive application security threats like log4j clearly demonstrated why every application needs web application firewall protection. As a result, we are seeing heightened interest in F5's WAF solution for both traditional and modern applications. In just one example during Q1, a customer selected NGINX with AppProtect to add WAF protection closer to a container deployed by its DevOps team. This is in addition to the advanced WAF operated by its traditional SecOps team. We also see growing demand for fraud and bot defense. As an example, in Q1, one of Central America's most prominent banks was still struggling with data security despite deploying multiple security solutions. The bank selected our shape solution to defend against persistent automated attacks. Shape has dramatically reduced the customer's automated traffic, successfully reducing the tumor friction across their digital channels. Shape is also providing fraud-based analytics for improved application security and visibility. Finally, customers' modern applications are moving into production and experiencing significant and constant swings in user demand. As a result, they need infrastructure that scales up automatically to meet user demands or down to save cloud costs. For instance, QAQ1, an American multinational investment bank and financial services customer, selected NGINX to help modernize their Kubernetes-based applications. The customer's existing solution was unable to provide multi-site resiliency for a service running within Kubernetes clusters. The customer selected NGINX Plus to provide multi-cluster, multi-site failover. Customers are increasingly looking to FIs to help them solve an escalating volume of application security and delivery challenges, and multi-cloud challenges, and modern map challenges like scaling Kubernetes-based apps into production. These challenges and the complexity they entail are only mounting for our customers. They see F5 as an innovator uniquely equipped to help them build and scale both the traditional and modern application environment. And the cloud-ready capabilities we are building with our Volterra and WebStack integrations only enhance our positioning and appeal. I'll now turn the call to Frank to review our Q1 results and our outlook.
spk03: Frank? Thank you, Francois, and good afternoon, everyone. I'll review our Q1 results before providing our Q2 outlook and updated fiscal year 2022 guidance. As Francois outlined, our team delivered another very strong Q1. First quarter revenue of $687 million is up 10% year-over-year and above the top end of our guidance range. Please note, as I review our revenue mix, I will be referring to non-GAAP revenue measures for the year-ago period. Q1 product revenue of $343 million is up 19% year-over-year, representing 50% of total revenue. Q1 software revenue grew 47% to $163 million, representing 47% of product revenue, up from 38% in the year-ago period. Systems revenue of $180 million is up 1% compared to Q1 last year. Rounding out our revenue picture, we see continued strength from our global services with $344 million in Q1 revenue. This is up 2% compared to last year and represents 50% of revenue in Q1. Taking a closer look at our software revenue, subscription-based revenue represented 81% of total software revenue, up from 77% in the year-ago period. Subscription-based revenue includes a ratably recognized as-a-service offerings and our solutions sold as term-based licenses. Revenue from recurring sources, which includes term subscriptions, as-a-service, the maintenance portion of our services revenue, totaled 68% of revenue in the quarter. On a regional basis in Q1, Americas delivered 17% revenue growth year-over-year, representing 59% of total revenue. EMEA was flat year-over-year, representing 24% of revenue, and APAC delivered 2% growth, accounting for 18% of revenue. The strength in Q1 spanned customer verticals as well, Enterprise customers represented 71% of product bookings in the quarter, service providers represented 15%, and government customers represented 14%, including 4% from U.S. Federal. I will now share our Q1 operating results. GAAP gross margin was 80.3%. Non-GAAP gross margin was 83%. Along with our increased component prices, we anticipate continued pressures related to our supply chain in the next several quarters. We expect these pressures will result in some increased costs related to expedite fees and sourcing of long lead time components. GAAP operating expenses were $438 million. Non-GAAP operating expenses were $345 million. Our GAAP operating margin in Q1 was 16.6%. Non-GAAP operating margin was 32.7%. Our GAAP effective tax rate for the quarter was 16.3%. Our non-GAAP effective tax rate was 19.5%. GAAP net income for the quarter was $93.6 million or $1.51 per share. Non-GAAP net income was $179 million or $2.89 per share. I will now turn to the balance sheet. We generated $90 million in cash flow from operations in Q1. We tend to see cash flow dip in Q1 as a result of the timing of cash receipts and billings amongst other factors. Q1's cash flow is below our recent range because of two primary factors.
spk12: First, we had strong multi-year subscription sales in the quarter. As a reminder, our multi-year subscriptions are generally sold on three-year terms.
spk03: We bill only one-third of the contract at signing, with the remainder going to unbilled assets. Second, during the quarter, we also had some significant prepayments with our contract manufacturer associated with the components for future builds. DSO for the quarter remained strong at 55 days. Cash and investments totaled approximately $936 million at quarter end. During the quarter, we repurchased approximately $125 million worth of FI shares or approximately 539,000 shares at an average price of $232. Capital expenditures for the quarter were $11 million. Deferred revenue increased 16% year-over-year to $1.576 billion, up from $1.359 billion. The growth in total deferred was largely driven by subscription and SaaS bookings, and to a lesser extent, deferred service maintenance. Finally, we ended the quarter with approximately 6,550 employees, up approximately 90 from Q4. This includes employees added with the threat stack acquisition, which closed in the quarter. Francois shared our Q2 revenue outlook and our updated fiscal year 2022 outlook in his remarks. I'll recap our full Q2 guidance and fiscal year 2022 updates with you now. Unless otherwise stated, please note that my guidance comments reference non-GAAP metrics. Let me start with Q2. We expect Q2 revenue in the range of $610 to $650 million as a result of supply chain-related systems production constraints. Taking into account continued component cost increases from 82 to 82.5%. As Francois discussed, because we believe the current supply chain challenges are transitory and do not reflect the underlying growth trajectory of the business, we do
spk12: not intend to adjust our operating model.
spk03: We believe doing so would risk compromising our ability to deliver future revenue growth. As a result, we are likely to see operating margin pressure in Q2 and for the next several quarters. I'll remind you that historically, Q2 is our seasonal low for operating margins as a result of annual payroll tax and retirement benefit resets. That said, we estimate Q2 operating expenses of $357 to $371 million. We anticipate our full fiscal year effective tax rate will be in the range of 20% to 21%, including the impact of our 19.5% Q1 tax rate with some fluctuations quarter to quarter. Our Q2 earnings target is $1.75 to $2.15 per share. We expect Q2 share-based compensation expense of approximately $65 to $67 million. Let me now review our updated fiscal year 2022 outlook. We expect fiscal year 2022 revenue growth in the range of 4.5 to 8%, reflecting a reduction of 30 to 90 million to our prior fiscal year 2022 revenue guidance. The higher end of this range provides for the potential of some additional supplier decommits. It does not, however, assume another step function deterioration from the level of decommit we have seen recently. We continue to be very confident in our software revenue growth range of 35% to 40% and expect to be closer to the top end of the range for the year. We also anticipate global services revenue growth of 1% to 2% for the year. Like other vendors, we have seen component cost and expedite fees escalate over the last year. As a result, in December, we announced we would be implementing a price increase of approximately 8% to our I-Series appliance platform, effective February 1st. We expect this pricing change will begin to positively impact gross margins in the second half of our fiscal year. We expect non-GAAP operating margin in the range of 29% to 31% for fiscal 22, with Q2 representing the low point for the year and operating margins improving in Q3 and Q4. We remain committed to regaining our target Rule 40 operating benchmark, where the combination of our revenue growth and non-GAAP operating margins total 40. We also remain committed to repurchasing $500 million in shares during the fiscal year. With that, I will turn the call back over to Francois. Francois?
spk05: Thank you, Frank. In closing, I'll note that we are making very good progress with our Volterra and ThreatStack integration, and you will be hearing more about our resulting SaaS-based solution offering very soon. We are major focused on doing everything in our power to mitigate supply chain impacts for our customers. Our future growth and our long-term opportunity will be driven by our software and our imminently launching software-as-a-service app security and delivery solutions. While we are sorely disappointed that supply chain challenges have gated our ability to fulfill customer demand for systems in the near term, we are more confident than ever in our position, our strategy, and our long-term opportunity.
spk12: Our performance expectations for their applications
spk05: while at the same time scaling to meet unprecedented demand and evolving their architectures to enable production scale and database infrastructures. With our adaptive application vision and our ability to serve any app anywhere, S5 brings cloud-ready solutions that close the gap between customers' traditional and modern application environments. Finally, I extend my heartfelt thanks to the entire S5 team for their steadfast focus and execution. My thanks to our customers and our partners for being on our journey with us and providing guidance and support along the way. With that operator, we will open the call to Q&A.
spk01: And as a reminder, to ask a question, you will need to press star 1 on your cell phone. To answer a question, press the pound key. For our first question, we have James Fish from Piper Sander. James, your line is open.
spk10: Hey, guys. Obviously, after hours, getting a lot on the supply chain stuff, and, you know, a number of your networking system peers took careful measures to ensure supplies and mitigate decommits. Why is this now impacting F5, or why wasn't it done
spk05: last quarter and what are you guys specifically seeing regarding your backlog that can really give us confidence that the demand side is still there hey uh jim it's francois and i'll take your um first question i um so let me just start from the the last one in your question then i'll come back demand the supply issue on the demand side um Jim, you know that last year our backlog continued to grow. I think we exited last year with a backlog that was at the highest level it's ever been.
spk12: In Q1, if you're referring specifically to hardware, you saw that our hardware revenue was pretty much flat.
spk05: But our backlog continued to grow in our first fiscal quarter. In fact, it grew by more than 10%. So based upon the demand we saw in Q1 and the pipeline we see in Q2, we feel very, very good about our demand and the health of the demand. And so the issue that we're facing, to be very clear, is not a demand issue. It absolutely is a supply issue. And the revision we've just done to our annual guidance is 100% linked to the supply issue. Now, to the first part of your question about what we've been doing to mitigate the issues and why are we facing this issue now. So we've been talking about for several quarters that the issue with our supply chain has deteriorated steadily. And last year, we were not able to shift the demand, which is why our backlog grew so much during the year. Things have been getting worse. And at the beginning of our fiscal year, when we were doing the planning for this year, we actually took into account the number of decommits that we were getting from various suppliers and a situation that was already very tight on number of components. Over the last 30 days, though, we have seen a step function decline in the state of component availability of a number of suppliers. And that's what's caused us to, you know, to relook at the view for the year and see that we wouldn't be able to even ship the systems that we had planned to ship for the full year. You know, to just give you a sense, Jim, the number of decommits, so we're now, you know, seeing over, you know, 400 decommits, you know, per quarter, and we were running about 30% less than that even just a month ago. So we are, you know, the situation is quite unprecedented. We are doing a number of things to mitigate these supply issues, working with companies uh our um you know our suppliers of course on escalations and allocations of supply to uh to us five uh we will be working on shifting some of our demand to we've introduced new uh hardware platforms that are just starting to ship uh recently and uh utilize more readily available components so we'll be working to shift some of the demand we have to these newer hardware platforms and we have a number of mitigation elements in place to improve the situation, but the supply chain is absolutely tight. The other thing that has changed in the last 30 days relative to where we were before is that we had been going to not just our suppliers, but also when we couldn't get the supply, we had been going to secondary markets, so on the open market through brokers, to get part of our supply. And that avenue has dried up, you know, really in the last several weeks because I think everybody is in the same situation and going through that. So those are some of the changes that have happened in the supply recently.
spk10: That's amazing color, Francois. And keeping on the supply chain stuff as a follow-up, I mean, how much of the supply capacity are we now at, given the B commitments, but also it sounds like new arrangements new arrangements with suppliers. And in addition, you guys talked about a mitigation timeframe for the fiscal second half. So does this mean we should expect upside to kind of fiscal 23 for where we're at, or is there risk to these orders getting canceled? Thanks, guys.
spk05: uh thanks jim let me just make sure so we don't see any risk to orders being canceled uh the demand we have is very real uh you know we our lead times unfortunately have have you know gotten progressively worse over the last uh you know five six quarters uh but we haven't seen any change in uh you know any increase in order cancellation and we don't expect to see that uh going forward um In terms of the timing of improvement, Jim, I want to clarify because there are two issues really at play here, and I want to make sure I give you visibility into both issues. So let me talk first about our fiscal year. So the $30 million to $90 million reduction to our revenue for the full fiscal year, That is linked to our struggle to get specialized networking chipsets that come from the big chip manufacturers. and our kind of specialized chipsets. The lack of supply of those is really what's driving that $30 to $90 million reduction. And we don't expect to see, part of why we're pointing to that reduction is that given the level of the commits we have in deliveries and the visibility that we have now from our suppliers, we don't expect this situation with specialized networking chipsets to get better until the very end of calendar 2022, which is when the new FAB capacity will start flowing into parts 2 and 5, and we would start to be able to ramp up our levels of shipment. So that's the situation that is affecting the full year. As it relates specifically to our second quarter in Q2, we have an additional challenge, which is more standard electronic components, where we have had a significant decommit in the last few weeks that is affecting only Q2 because we expect to be able to qualify alternative parts relatively quickly and make those shipments in Q3 and Q4. So the second issue has a much shorter timeframe to be resolved. The first issue is the bigger issue around the specialized networking chipsets that will take several quarters before we see meaningful improvement there.
spk01: For our next question, we have Sami Badri from Credit Suisse. Sami, your line is open.
spk02: Hi, thank you. First, Francois and maybe Frank, you could also help us as well. Can you just kind of unpack the growth algorithm of software and just how we got to this point? you essentially exceeded expectations on a very strong comp prior year. Can you just unpack what exactly it was that got you to this result? So that's the first question. The second question is, as I hear you describe the degree and the magnitude of the supply chain constraints, it almost sounds so strong that it would almost compel the customer to change architecture because of the degree of the effect of what's happening. like a service, for example, what they had in mind. So how come what's going on, what you guys are saying, the delays, and essentially what sounds like a systemic problem is not compelling customers to, say, adopt more software-type architectures or solutions and sticking to specifically hardware? And then, you know, thank you. That would be great.
spk05: Thank you, Sandy. I'll start with the second part of the question, then we'll do the software. And I'll start with the software answer, and then Frank may add to it. So, Sammy, as it relates to the supply chain issue, I just want to put it in the perspective of what our customers are seeing and what lead times they're seeing. Historically, our lead times were two weeks or less. They're absolutely world-class. And I mean that sort of you know, pre, you know, 2021. As our lead times got worse in 2021, they extended to four to five weeks. And I would say for the last several quarters, we've been in that kind of five-week zone. For orders that are placed today by customers, the lead times have extended, but they're going to be in the range of six to 18 weeks, depending on the platform and the specific product that a customer is ordering. So while these lead times are, of course, worse than we've ever had them, they're still in the zone of kind of four to four and a half months at the high end, which you can check with other vendors around the industry in our space, and you'll find that those lead times don't stand out as being worse than anybody else. And I think our customers have adjusted to having longer planning cycles, you know, for the environment that they're building. So we are not seeing customers as a result of extended lead times start to, you know, completely rethink their architecture. I think if our lead times were to become 12 months or more, you know, we would see a much different behavior. But we don't see that and we don't expect that even with the, you know, the challenges that we're having at the moment shipping to customers. So that's on the first part of your question, Sami. On the software question, we did indeed have a very strong software quarter, and it's because the three drivers of growth in software as part of our strategy are essentially all going to plan. So let me start with the first part. So the three drivers are what? It's, you know, driving growth in traditional applications to software-first and multi-cloud environments. Second, scaling our modern application franchise. And third, security. So let me unpack these three drivers for you, Sami. So the first one... You know, we have seen, you know, broad-based strength in enterprise for software for big IP. Specifically, I would say financial services and service providers were strong this quarter. We also saw kind of more resumption of customers who have said they wanted to move to software and have put that a little bit on pause in the first quarters of the pandemic. We're seeing more of those customers moving with their migration to software-first architectures. even for traditional applications. And so that is helping with seeing very strong second-term renewal and true forwards for our multi-year subscription agreements. So all of that is contributing to strength in traditional applications growth in software. The second aspect is modern applications, which we largely support with NGINX. We did over 500 deals with NGINX this quarter, which is a record. We're continuing to see the average size of deals increase because of the additional products we have released as part of NGINX. And we are also seeing a lot of applications that are in Kubernetes environment go in production and scale. And what customers are really seeing with Kubernetes is that the networking and security issues that are associated with Kubernetes are pretty challenging. And Kubernetes really abstracts this complexity for developers. But NetOps teams still have this complexity to deal with. And the networking and security challenges for Kubernetes are very different. than what they've done in a more traditional environment. And NGINX is really the ideal complement to Kubernetes to address these challenges. And so we're seeing a lot of traction with these deployments. And the third driver is security. And security continues to grow faster than our overall product revenue. And this quarter, we saw strength in security across the entire portfolio. We saw strength in big IP. We're seeing more customers adopt our web application firewall. That has accelerated, and frankly, the log4j vulnerability brought awareness to a number of customers that either didn't have our WAFs or didn't have it activated to really, you know, use that to protect their perimeter. The customers that had a WAF in place, you know, were able to protect their perimeter their perimeter and then have a lot more time to patch other parts of their infrastructure. We're also seeing customers move beyond web application firewall and add, you know, anti-bot and API security as a bundle. We continue to see growth in NGINX security. And then Shape had a strong order. We had the, you know, probably our best order in terms of new logo acquisition. We started to see broader-based adoption in new segments like service provider and also internationally with shape, in part because of the continuing product maturity, in part because of the go-to-market maturity that we now have. And we're also seeing traction with cloud marketplaces. We completed the integration of Shape into Salesforce.com's e-commerce platform so that our bot technology is visible to all of the players in this marketplace. and have other integrations with cloud providers that are also starting to contribute. So, you know, you look at across all three drivers of software, we really had, you know, strong momentum and strong execution. And, you know, we're really pleased with where we are on software.
spk02: Got it. Thank you.
spk01: For our next question, we have Amit Dharbiani from Evercore. Amit, your line is open.
spk05: Thank you for taking my question, too, as well. You know, first off, I'm hoping we can just help you reconcile the March quarter and fiscal year guide. And, Frances, I thought I heard you talk about the two different component challenges that you have. But, you know, your March quarter guide, I think, if you take it at midpoint, implies In the first half, you'll grow 3.7% or so. But then for you to hit your full year guide, it almost implies that you have to grow high single digits in the back half of the year, June and September. So am I doing this correctly? And I guess why the confidence that growth will snap back so quickly in the June, September quarter for you folks?
spk03: Sure. I mean, why don't I start with that one and then see if Francois has anything to add. So I think, you know, Francois tried to articulate the difference of the near-term challenges we're having in Q2 and some of those acute standard components that are just taking a bit of time to redesign into the solution. But we are able to make up for some of that loss in the back half of the year. And so it's more acute because of just the timing of when we realized that this part that we expected to get this quarter is now not coming until next quarter, and it's going to come in much less than what we initially had ordered. And so this redesign that we are doing for this part is not going to be in place in time with our manufacturers to affect Q2 revenue, but it will impact, we will have ability to quote-unquote catch up on that in Q3 and Q4. And so that's what gives us confidence that Q2 is the low mark when you take the combination of the two quarters that you just said, yeah, for the first half that way. But we do make up for some of that Q2 demand in the back half on top of the ordinary demand that we would normally see.
spk05: Got it. Perfect. And then, you know, I guess the second one, and, you know, this almost seems silly to ask, given all the hard issues you have, but, you know, on the software side, you know, and Francis, you talked a fair bit about this, but, you know, you did 47% growth on probably one of the more difficult compares. I think it was 70% last year. And your guide sort of right now, the full year, would imply that your software growth will decelerate as your compares start to get easier. That seems a little counterintuitive, and I guess there's a need to be conservative, given the supply chain issues you have, but I'd love to understand why do you think software decelerates after everything you talked about that doesn't? It's a good question. We don't necessarily think it decelerates. We are early in the year, and we gave a range for the full year of 35% to 40%. We had a very strong first quarter. We feel very confident about our software growth. In fact, we said, hey, we think it's going to be more at the top end of the range. But, you know, it's too early to be, you know, changing that view for now. And what you should take away from our stance is that we really like what we're on software, and we think it's going to be a very good software year. Fair enough, and best of luck. Thanks for your time. Thank you, Amit. Thanks, Steve.
spk01: For our next question, we have Alex Henderson from NIDA. Alex, your line is open. Thanks, Sandy.
spk04: So I wanted to ask a broad general question about the behavior of enterprise's purchasing approach given the intense pricing pressure and supply constraints around hardware. As you've talked to CIO, CTO, C-suite type people, Has it resulted in a change in behavior where we're seeing an acceleration in commitments to digital transformations? I mean, switching prices, I think Cisco just kicked their price up again this month. You know, switching prices are a double digit, and they're forcing people into these subscription markets. around those hardware, a lot of people, I would think, increasingly wanting to get away from that, and that would play into your strength, I would think, to the extent that you're such a strong player in the Kubernetes workspace, workload space. So can you address what you're hearing from the C-suite on those thoughts about changing their behavior in a more cloudy fashion?
spk05: hi alex um so i i would first i would say alex you know our we know we are going through an extraordinary situation as it relates to supply everybody along the value chain is feeling that um you know and you're seeing different types of behaviors in some case you are seeing some suppliers in the semiconductor space who you know are taking advantage of that to you know to some extent gouge on prices uh and that you know we believe is a short-term approach that may have some benefits but in the long term it's detrimental to relationships and so you know the way we look at it is you know our our customers and our shareholders are going to be happy if we continue to have great long-term relationships with our customers uh and continue to be with them as they evolve their architectures and so as we think about you know, how do we balance the cost pressures with price increases, we are looking at it through the lens of also, you know, maintaining strong relationships with our customers for the longer term. So we're always, from our perspective, we're always going to have that balance in how we approach things. In terms of the way, you know, our customers are seeing things in our conversations, you know, Of course, they want to get their products as fast as possible. In the case of F5, we are not seeing them, as I said before, we're not seeing order cancellations. We're not seeing them double ordering solutions because F5 solutions is unique and you can't replace them life for life for something else. And frankly, also because so far we have managed to keep our lead times that are much better than what they're getting from other vendors. So we are getting increasing pressure, of course, from customers to try and, you know, supply to them faster. You know, but we're not seeing a dramatic change in their behavior towards F5 from what we saw through last year.
spk04: If I could follow up on a separate question, Peyton. The service provider business historically has been in the 20% to 23% of revenues range. It's been coming down persistently every quarter. I think you're talking about 15% this quarter. It seems quite clear that with your shift to software and security that you've shifted resources away from them. Can you talk about that? to what extent you're shifting away from, intentionally shifting away from that space in favor of your higher growth alternative areas?
spk05: Alex, I would not say that we are intentionally shifting away from the service flight space. We had a very strong You know, through the last five, six quarters, we have very strong demand in the enterprise that has been broad-based. And so when you look at the mix overall, service provider as a mix has come down. However, our service provider business itself, you know, has actually been growing very healthily over the last several quarters, including this last quarter. And also with what we're seeing coming in the 4G to 5G transition, we see strong opportunities both in hardware and software with service providers with some potentially important deals to come over the next two quarters. And so, no, we are actually investing into the service provider space, both for our existing platforms and Volterra, that is also potentially a platform of very strong interest for service providers. We are starting to see more and more deals in the IoT space with service providers, oftentimes requiring scale to tens of millions of devices. which for that scale is served through hardware. So we continue to invest in our service provider segment. I understand how you drew that perspective from the mix. Service provider has been only at 15% for the last few quarters, but it is growing in line with the rest of the business with very strong prospects to come.
spk03: And Alex, just as a reminder, that 15% is of bookings, not of revenue, and certainly not of total revenue. So As a proxy, you can go about it in relation to product revenue, but that's what it's in relation to.
spk04: Thanks.
spk03: Thank you, Alex.
spk01: For our next question, we have Rod Hall from Goldman Sachs. Rod, your line is open.
spk09: Yeah, hey, guys. Thanks for the question. I wanted to start by clarifying the backlog number. I think, Francois, you said it grew just over 10%, and I think you guys had called out $125 million of backlog last quarter or so. Is it right to think that that backlog is in the ballpark of $140 million this quarter?
spk03: It's in the ballpark for the system side. What Francois was referencing was the systems piece of the backlog, which, as we said, in our case was the vast majority of that $125 million, but I just want to make sure you understand that it's in the nation's
spk09: So just shave a little something off the 125 and up by 10 plus and that puts it in the ballpark. Okay, thanks, Ron. That's helpful. And then I wanted to just kind of ask a bigger picture question. You guys last year were talking about systems being stronger because people were locked down and they couldn't test software in. This kind of comes back to, you know, what people might be thinking here. So now you're in a situation where you can't supply systems people want. I don't get why, because it looks to me like you've raised your software guide by maybe $12 or $13 million, you know, from your midpoint of your 35 to 40 to 40. But then you're cutting your systems guide by 30 to 90, so quite a bit more than that. So you're not really getting that. It just seems like you should get an accelerating trade towards software. if that dynamic last year started to unwind in your favor this year. So I still don't fully understand, you know, why the software is not going up more to compensate for the hardware weakness.
spk05: Juan, great question. So I first want to remind you, Juan, that where there is an opportunity to substitute, if you will, hardware for software is really in our big IT platform. But the drivers of software growth are across the entire portfolio. So that's the first thing you got to remember. Second, when you say, hey, why is there not more substitution in the IP of hardware for software? But the first reason is because hardware demand is not weak. So the behavior of our customers as it relates to hardware hasn't changed. The hardware demand continues to be strong. We saw broad-based demand in the enterprise on systems. Security use cases continue to drive systems demand, and we see existing security customers even extend their FI security footprint in hardware. And generally, application growth, traditional application growth continues, and therefore, our hardware demand to support this application continues to be very strong. So there hasn't been a change from a demand perspective. The issue we have is a supply issue. So that's the second reason you're not seeing a big substitution effect. Now, you could ask, well, okay, but if our lead times get much worse, will that encourage more customers to change their demand from hardware to software? And on the margins, we think there may be a slight element of that, which is part of what's causing us to say, hey, maybe we're closer to the top of the range, but to the top of the range on software. But we think that's a marginal effect because when customers look to say, hey, I'm going to go to a software-first environment, first of all, F5 is not the only consideration that they have. There are other vendors that are part of their environment that drive that architectural decision. And second, I think our lead times would have to really extend well beyond six months for just a lead time factor to cause our customers to really change and look at software. You know, with all of that being said, with the supply challenges that we're having, you know, our teams, when working with customers, if a customer is on the margin and really could go one way or the other, I think, of course, we'll encourage them to move to software because they can get there much faster. But we don't look to that as a thing that's going to shift, you know, multiple tens of millions of dollars from one consumption factor to the other.
spk09: Great. Okay, Francois. I really appreciate all that, Collin. Thank you.
spk05: Thank you, Rod.
spk01: For our next question, we have Nita Marshall from Morgan Stanley. Nita, your line is open. Great. Thank you.
spk08: I just wanted to get a sense, you know, you noted kind of the shortages you're seeing are two-pronged, both on the specialized chips and the more standardized components. Just wanted to get a sense of, you know, was the deterioration you saw more severe in kind of one or the other in the quarter, and just, you know, What guidance kind of implies at top, bottom of the range? Does one have to improve more than the other to kind of achieve those? And then maybe just a second question for me. You know, we've seen a lot of the networking peers kind of build inventory pretty significantly or attempt to build inventories pretty significantly over the course of the last year. You know, just as going forward, getting out of this, does this kind of change your thoughts on inventory stocking going forward? Thanks.
spk05: Yes, just a couple of, let me start with the last part of your question. So we have been, you know, buying components with extraordinarily long lead times. Some of the components that were decommitted at the very beginning of the calendar year for us were components that we had ordered more than 52 weeks ago. We have several hundred components today that have more than two years lead time. So we have been getting ahead of this for the last 18 months and making very strong advance buys in anticipation of issues, getting commitments from suppliers that in some cases, after 52 weeks of waiting, are coming back when the deliveries are due and saying it's not going to happen in the quantities you expected or the timing you expected. And so, you know, that and we've been able to manage that through the last several quarters, but we've seen even a step function deterioration on that just in the last 30 days. Now, to your question around is one issue more severe than the other in terms of the two issues we are seeing, I think there are really two dynamics. The first issue, which is the specialized networking chipset you know, from the large kind of, you know, specialized chip manufacturers. That issue is going to take a while to get better. It is about way for capacity and more capacity coming online, you know, for us to get the parts that we need to have ultimately. And that's going to take several quarters. And in the range of 30 to 90 that we have assumed, to be very clear, we have assumed that in there the potential for more decommits than what we have seen to date, but we have not assumed yet another step function deterioration from the levels at which we're at to date. So that's kind of the, you know, the 30 to 90 range. And to get closer to the 30 million, we would have to be successful in shifting some of the demands towards our newer platforms, and we're already working actively on those programs. As it relates to the in-quarter issue of Q2, specifically the standard component, this really is, you know, it's to do with the timing of the specific decommit for a couple of parts. That is really unfortunate for parts that, you know, we had on order for a very long time. And, you know, the timing of that decommit makes it such that we can't, you know, we qualify the other parts and design around it and be able to ship in quarter we will re-qualify. There are alternatives available in the market, so we'll be able to get our parts, and we will be able to recover that starting in our Q3. So that's more of a shorter-term issue.
spk01: Got it. Thanks.
spk05: Thank you, Meta.
spk01: For our next question, we have Samit Charterji from J.P. Morgan. Samit, your line is open.
spk06: Hi, thanks for taking my question. I guess if I could just start with a non-supply question here. Francois, given some of the temporary issues you're seeing here, you reiterated buying back about 500 million in the nation, or what's the appetite to maybe aggressively do a bit more? The outlook for the business longer term hasn't changed, but this temporary setback obviously is going to drive some weakness on the share price.
spk12: Sure.
spk03: Let me start with that one. We talked about the $500 million of share repurchase maybe more reliably throughout the course of the year. We've established automated share repurchase programs associated with that. I'm not going to get into the ins and outs of the execution of that program, but the But we haven't changed the level of commitment that we intend to make. It's still $500 million. When exactly that triggers, you know, I think that program up from $500 million because we want to stay balanced on the strategic reasons why we entered into that kind of balance in the first place.
spk11: Got it.
spk06: And just to follow up on software, you've talked particularly last year about the true benefit from or will be a deal win in terms of growth this year. How should we think about the trajectory of those? Are those more weighted towards the back half? I think in general, as we look at the risk in terms of your software guide, I think to an earlier question, it does imply something.
spk11: Is there an impact there on the true forward on certain half of the year?
spk03: So the true forwards, you know, there's some seasonality to them. What we talked about is really the second term of the multi-year subscription agreements coming into play, which resets the whole cycle of revenue recognition with a second term, and those were more weighted in the back half.
spk05: Okay, good. Thank you. Thank you, Sammy.
spk01: Due to time constraints, we will take our last question from Paul Severson from Cohen. Paul, your line is open.
spk13: I appreciate you all squeezing me in, and I appreciate all the questions in response to supply chain. If the $30 to $90 million, if I understand you correctly, if the $30 to $90 million shortfall relative to your original $90 to fiscal 2022,
spk12: is all related to the specialized chipset. Trust your view, your understanding of when the new supply, when those new fabs would come online hasn't changed over that 90-day period.
spk13: You didn't expect to benefit from those companies. or the current available chipsets.
spk12: Is that correct? Yeah. All right.
spk13: Is it a given that if you're not losing, if your customers aren't shifting to your software, the customers who are purchasing the hardware, if they're not shifting to your competitors' software, Is it a given that your backlog will increase by $30 million to $90 million, whatever the day-ago expectation? That's just basic math, isn't it?
spk05: Pretty much. I mean, it's forecasting backlog exactly.
spk12: We're probably not going to do that, but yes.
spk05: our backlog will increase by multiple tens of millions of dollars starting this quarter, of course, in Q2, but even for the full year, yes, we expect our backlog to increase because we cannot shift the demand.
spk13: If I could squeeze in one more, I'm going to apologize again, and if it's already been clear, but given that you're almost a full month into the quarter, why the significant range in the guidance for the quarter? Just that the visibility and confidence as to additional decommits, it's just not, it's sparse, if you like a better way to put it. What accounts for that dramatic range in the near term? I mean, you've only got two months left in the quarter. And I assume you had to build up supply previously, as everybody else has been doing, in terms of advanced ordering in order to ship against whatever you had expected Once again, why such a dramatic range?
spk05: Well, that's a great question.
spk12: And, look, absent the significant supply chain challenges that we have, you would have probably seen a range that would be closer to sort of $20 million.
spk05: And the range is twice that for two reasons. And they're both related to price.
spk12: to solve some of that in quarter.
spk05: And so, you know, that's to, you know, do all of that kind of design work and get that to manufacturing and be able to ship these parts, you know, before the end of March, sorry, there is an added uncertainty
spk12: that comes from that. And then the second part of that uncertainty is also in quarter, we are looking to shift some of the... How fast we can ramp those platforms... So those are the two elements of supply that could go one way or the other that... Add a little more uncertainty to...
spk05: to the column, this is why you see the wrench. But I want to be very clear. Both are related to supply. They're not related to, you know, some worries we would have about demand. You know, we, of course, are working 24-7 to do this. It's because ultimately, you know, our North Star is getting products to our customers.
spk12: And we understand that the lead times are extended.
spk05: for them, and we want to be able to satisfy the demand as fast as possible for customers that are waiting on lists and for their applications that are growing.
spk01: And ladies, you may now disconnect.
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