F5 Q4 2021 Earnings Call Transcript

Quartr
Provided by Quartr
October 25, 2021

There are 14 speakers on the call.

Operator

Good afternoon, and welcome to the F5 4th Quarter Fiscal 2021 Financial Results Conference Call. At this time, all participants are in a listen only mode. After the speaker presentation, there will be a question and answer 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.

Operator

Suzanne Doolong. Ma'am, you may begin.

Speaker 1

Hello, and welcome. I'm Suzanne Doolong, F5's Vice President of Investor Relations Francois Lobo Denou, 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 and A session. A copy of today's press release is available on our website atf5.com, where an archived version of today's call will be available through January 25, 2022.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.

Speaker 1

To access the replay of today's call by phone, dial 800-585 8367-four 166214642 and use meeting ID 6,879,935. The telephonic replay of this call will be available through midnight Pacific Time, October 27. For additional information or follow-up questions, please reach out to me directly at s.dulongf5.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.

Speaker 1

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.

Speaker 2

Thank you, Suzanne, and hello, everyone. Thank you for joining us today. Under pandemic conditions that have persisted Far longer than anyone initially expected, the F5 team delivered another very strong quarter, closing out a robust year for us. Customer demand for application security and delivery amid skyrocketing application growth and heightened application security awareness are driving strong demand for FI solutions. This demand spanned our portfolio and our regional theaters in Q4, driving 11% revenue growth and our 4th consecutive quarter of double digit revenue growth.

Speaker 2

We delivered 35% software growth, 12% systems growth and 2% global services growth in the quarter. With software revenue representing 45% of product revenue in the quarter and 80% of our software coming from subscriptions, We continue to mark milestone after milestone in our rapid transformation to a more software led business. I will speak more about our business Frank?

Speaker 3

Thank you, Francois, and good afternoon, everyone. I'll review our Q4 results before briefly recapping our fiscal year results. As Francois just outlined, our team delivered another very strong quarter. 4th quarter revenue of $682,000,000 is up 11% 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.

Speaker 3

Q4 product revenue of $340,000,000 is up 21% year over year, representing a significant acceleration from 6% in the same period last year. Q4's software revenue grew 35 percent to $152,000,000 representing 45% of product revenue, up from 40% in the year ago period. Systems revenue of $188,000,000 is up 12% compared to Q4 last year when systems were down 8%. Rounding out the revenue picture, we continue to see strength from our global services at $342,000,000 in Q4, up 2% compared to last And representing 50% of revenue. Taking a closer look at our software revenue, customers' preference for subscription based consumption models is evident.

Speaker 3

In Q4 'twenty one, subscription based revenue represented 80% of total software revenue, up from 76% in the year ago period. Subscription based revenue includes our ratably recognized as a service offerings and our solutions sold as term based licenses. Within subscriptions, customer demand is driving substantial volume and value growth from our multiyear subscriptions. The deal volume of our multi year subscriptions more than doubled year over year and is approaching 500 in total. This consumption model consumption patterns.

Speaker 3

In addition, we ended the year with more than 600 SaaS and managed service customers, reflecting growth of 50% year over year. 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 67% of revenue in the quarter. On a regional basis in Q4, Americas delivered 11% revenue growth year over year, representing 59% of total revenue. EMEA delivered 11% growth, representing 4% of revenue and APAC delivered 9% growth accounting for 17% of revenue. The strength in Q4 spanned customer verticals as well.

Speaker 3

Enterprise customers represented 69% of product bookings in the quarter, service providers represented 13% and government customers represented 18%, including 8% from U. S. Federal. I will now share our Q4 operating results. GAAP gross margin in Q4 was 81.1%.

Speaker 3

Non GAAP gross margin was 83.7%. GAAP operating expenses were 427,000,000 Non GAAP operating expenses were $350,000,000 Our GAAP operating margin in Q4 was 18.5%. Non GAAP operating margin was 32.4%. Our GAAP effective tax rate for the quarter was 10.3%. Our non GAAP effective tax rate was 15%.

Speaker 3

GAAP net income for the quarter was $111,000,000 or $1.80 per share. Non GAAP net income was $185,000,000 or $3.01 per share. I will now turn to the balance sheet. We generated $197,000,000 in cash flow from operations in Q4. Cash and investments totaled approximately 1,040,000,000 Deferred revenue increased 17% year over year to $1,489,000,000 up from 1.2 $73,000,000,000 The growth in total deferred was largely driven by subscription and SaaS bookings growth and to a lesser extent deferred service maintenance.

Speaker 3

Finally, we ended the quarter with approximately 6,460 employees, up approximately 80 from Q3. This does not include approximately 90 employees added with the ThreatStack acquisition, which closed in our fiscal Q1 of 2022. I will now briefly recap our full year 2021 results. For the year, revenue grew 10% to 2,600,000,000 Product revenue of $1,250,000,000 grew 21% from the prior year and accounted for 48% of total revenue, up from 44% in the year ago period. Within product revenue, software grew 37% to $500,000,000 a beat on our outlook atorabout35% growth for the year.

Speaker 3

Systems revenue in FY 'twenty one grew 12% to 748,000,000 Global Services grew 2% to $1,360,000,000 representing 52% of total revenue. Looking more closely at our software revenue, since fiscal 2018, we've grown our software revenue at a 49% compounded annual growth rate and our software subscription revenue at 115% compounded annual growth rate. GAAP gross margin In FY 'twenty one, it was 81.1%. Non GAAP gross margin was 83.9%. Our GAAP operating margin in FY 'twenty one was 15.1% and our non GAAP operating margin was 31.6%.

Speaker 3

Our GAAP effective tax rate for the year was 14.4%. Our non GAAP effective tax rate for the year was 17.7%. GAAP net income for FY 'twenty one was $331,000,000 or $5.34 per share. Non GAAP net income was $671,000,000 or $10.81 per share. Application security Is a big and growing reason customers turn to F5.

Speaker 3

Our application security offerings, including DDoS Protection, Advanced vulnerability defense for web application firewall and bot fraud and abuse protections are increasingly recognized as industry leading. As a result, we estimate our standalone security product revenue grew 26% in FY 'twenty one to approximately 350,000,000 reflecting a 38% compounded annual growth rate since FY 'eighteen. Including bundled security offerings And an estimate for our services revenue associated with security, we estimate the total application security portion of our business grew to more than $900,000,000 in FY 1, representing approximately 35% of total revenue. Supply chain challenges have been well acknowledged across the industry over the last year. Our supply chain team continues to do an impressive job managing global supply chain constraints and working through In part as a result of supply chain constraints, we ended FY 'twenty one with approximately $125,000,000 in backlog, the vast majority of which is system based.

Speaker 3

Now let me share our guidance for our Q1 as well as some color on our view for FY 'twenty two. Unless otherwise stated, please note that my guidance comments Let me start with sharing our expectations for the Q1 of 2022. We are targeting Q1 revenue in the range of $665,000,000 to $685,000,000 implying roughly 8% growth at the midpoint. We expect Q1 'twenty two gross margins of approximately 84%. We estimate operating expenses of $342,000,000 to $354,000,000 Our Q1 earnings target is $2.71 to $2.83 per share With a share count of approximately 62,000,000 we expect Q1 share based compensation expense of approximately 64,000,000 to 66,000,000 Now let me share some operating expectations for our 2022 fiscal year.

Speaker 3

For the year, we expect revenue growth of 8% to 9%. We expect software growth of between 35% 40%. We expect the range of software variability we will Quarter to quarter will narrow relative to what we have experienced in the past. This is due in part to what we We expect systems revenue growth will be flat to slightly up for the year and we continue to expect low single digit global services revenue growth. I note that all of these revenue expectations are at or above our most recent Horizon 2 outlook provided in January with the Volterra acquisition announcement.

Speaker 3

We anticipate continued pressures related to our global supply chain in the next several quarters. We expect these pressures will result in some increased costs related to the expedite fees and sourcing of Long lead time components. In light of this dynamic, we anticipate non GAAP gross margins of approximately 83.5% to 84% for the year, and we will continue to closely monitor this situation as we have throughout the past year. We continue to target operating on the Rule of 40 basis where the combination of our revenue growth and non GAAP operating margins totaled 40. The combination of our strong FY 'twenty one revenue growth And our continued operating discipline enabled us to achieve the Rule of 40 in 4 out of 4 quarters in FY 'twenty one ahead of our initial horizon 2 target.

Speaker 3

We continue to target achieving the rule of 40 in FY 'twenty two. Given our anticipated revenue growth and the ongoing benefits from the cost reduction initiatives that we discussed at our Analyst and Investor Meeting last year, we expect non GAAP operating margin in the range of 32% to 33% for FY 'twenty 2. We expect our typical operating margin seasonality, which translates to operating margins stepping down in Q2 and improving in the back half of the year. We anticipate our full fiscal year effective tax rate will be at or around 21% with some fluctuations quarter to quarter. Fiscal 2022 stock based compensation expense in the range of $250,000,000 to $270,000,000 and capital expenditures in the range of $40,000,000 to 60,000,000 Finally, for the year, we expect share count to remain at approximately 62,000,000 shares, inclusive of the expected share repurchase $500,000,000 during FY 'twenty two as we previously discussed.

Speaker 3

With that, I will turn the call back to Francois. Francois?

Speaker 2

Thank you, Frank. Our very strong 4th quarter results are the perfect cap to our robust outperformance in FY 'twenty one. In the last 18 months, Our reliance on application, both as businesses and as consumers, have escalated sharply and likely forever changed. Our customers are massively accelerating digital transformation to keep up with current demand and forecasted growth. They are doing this while also working to consistently meet consumers' high expectations for application performance and availability And while also ensuring their application and their consumers' data are secure.

Speaker 2

In my conversation with investors, I am often asked what is potentially misunderstood about F5. Let me address the key points here. First, traditional on premise applications continue to grow counter to the prevailing expectations from 2 to 3 years ago. In fact, Traditional apps are generating more traffic and more revenue than ever because every aspect of life and business Relies on applications. For F5, this means BIG IP demand will continue to grow in both software and systems form factors.

Speaker 2

2nd, Contrary to early cloud hype, the vast majority of traditional applications are not being refactored. They are either remaining on premise or they are moving to the cloud with a lift and shift motion. In other words, F5 run applications are remaining attached to F5. As a result, BIG IP is growing both on premise and in public cloud. 3rd, modern container based applications continue to grow at a rapid pace And not only for new applications, customers are bolting new modern components onto traditional applications to improve the user experience.

Speaker 2

In many cases, cloud native application security and delivery simply are not robust enough to meet the application's needs. For F5, this means accelerating NGINX demand, enabling app security and scale for modern application, often as a complement to BIG IP. And finally, given the volume of business and data that is now flowing through application And the increasingly distributed nature of applications, application security has taken on new significance. Where in the past, Network and infrastructure security was a focus for customers and vendors alike. We expect application security will be one of the hottest areas of investment over the next F5 is one of the few players 100% focused on application security, And we protect not just access to applications, but also how they are used.

Speaker 2

As a result, we expect our role and reputation As a leading application security provider, we'll accelerate. To sum up these points, S5 It's differentiated and well positioned to benefit from significant emerging secular trends. There are some companies focused on applications. There also are some focused on application security. F5 is the only one that is at the epicenter of these 2 secular forces With a focus, expertise and the technology assets to secure and deliver any application anywhere.

Speaker 2

Let's ground our opportunity in real customer trends and use cases. Last quarter, I talked about 5 sustainable customer trends we expected to drive demand across our portfolio. Let's revisit those trends with some customer examples from Q4. Number 1, Enterprise customers, developers and DevOps teams are using NGINX to insert security earlier in the application lifecycle. NGINX without protect delivers robust application security for microservices with the flexibility and agility developers demand.

Speaker 2

In one example, during Q4, we secured a NingenX win with a global insurance group. They are migrating their consumer facing insurance services into a public cloud. For risk mitigation and security reason, they required a scalable and container friendly solution. They also needed enterprise grade security capable of protecting their strategic high value apps and guaranteeing risk management compliance. And they wanted all of this within a lightweight footprint that could drive automation, saving time and money.

Speaker 2

NGINX With App Protect was a natural choice. Trend number 2, heightened security concerns and high With pronounced application growth and an ever expanding threat landscape, including high profile ransomware and financial staffing attacks, We see growing demand for application security in cloud environments and rising demand for fraud and bot defense. During Q4, a North American electric utility experienced a credential stuffing attack resulting in substantial infrastructure failure. More than 6,000,000 customers have to reset their account passwords. Based on their experience as a BIG IP customer, the utility turned to F5 for help.

Speaker 2

Shape was emergency onboarded, identified high volumes of automated traffic and deployed highly effective mitigation measures to stop the attack. Trend number 3, customers are leveraging F5 for Kubernetes, containers and cloud native architectures. Our growth in modern application continues to accelerate, driven by NGINX Kubernetes and cloud native deployments. We are seeing several top use cases emerge for NGINX, including managing API, optimizing Kubernetes traffic management And load balancing cloud native and hybrid cloud applications. With customers' modern applications experiencing significant and Constant swings in user demand, they need infrastructure that scales up automatically to meet user demand or down to save cloud costs.

Speaker 2

During Q4, a Canadian online investment manager selected NGINX to move their Kubernetes based applications into production At scale, initially, they attempted to use a competitive solution, but it lacked performance and did not integrate well with their HashiCorp console Or with AWS Auto Scaling, NGINX Plus delivered low latency and high uptime to improve user experience And integrated seamlessly with AWS Auto Scaling to spin down half of their instances during off peak traffic demand. Trend number 4, customers are scaling their existing hardware based infrastructures to handle accelerating application growth, Driving continued strength for BIG IP Systems. We are finding that customers are often looking to scale both their existing infrastructure And their modern apps infrastructure simultaneously. This is particularly true among tech and SaaS provider customers We continue to experience rapid adoption and growth of their digital products and services. In the latest of a growing list of examples, during Q4, A high growth SaaS provider selected F5 to help them scale both the traditional apps on BIG IP and their modern public cloud apps with NGINX.

Speaker 2

This deal was made sweeter by the fact that NGINX displaced a competitor that wasn't performing as promised. Finally, trend number 5, customers are leveraging BIG IP for transformation, including cloud migration and automation initiatives. The demand we are seeing for BIG IP systems and software is about more than just capacity additions. Customers also are choosing BIG IP to drive transformation, Often combining it with NGINX, F5 is particularly well suited for enterprises that operate both modern and traditional applications, which most do. NGINX integrations with BIG IP provide differentiation over competitor and cloud native offering, and we will extend this The customer who processes more than $1,000,000,000 annual transaction needed hybrid on premises data security as well as the ability to support Monon app development and new engaging multimedia capabilities.

Speaker 2

They selected BIG IP and NGINX and the foundation for their digital transformation. Let me touch briefly on service providers and our Voltera integration progress before concluding our prepared remarks. We had a good year with service providers in FY 'twenty one. While it's true that several of the trends I have just described also apply to our service provider customers, They also faced unique challenges as a result of 4 gs to 5 gs migration and growing 5 gs traffic demands. Thus far, our service provider demand has come largely from 4 gs core network upgrades as they expand hardware capacity And upgrade existing infrastructures to handle 5 gs traffic.

Speaker 2

We expect software use cases will begin to emerge As carriers virtualize their 5 gs cores. Looking forward, our Voltera platform is generating significant interest from service provider. They view it as a way to insert their capabilities at the edge, thus creating 5 gs in a box offerings. That offers a good transition to discussing progress on the integration of Voltera. Voltera is a universal edge platform, which will enable us to insert Critical application services at the edge and allow our customers to consume these services in a fast format.

Speaker 2

Our initial priority is on security offerings. We have one of the best, if not the best application security software stacks in the industry, including our web application firewall, Our VDoS protection, API security and BOS capabilities. We are taking that entire security stack and integrating it natively into the Voltera platform. Our first priority is a fast security offering that will address the shift toward modern Web apps and APIs, and we are on track to deliver within our committed 12 to 18 month integration window. Our recent acquisition of ThreattBank, A leader in cloud security and workflow protection is designed to accelerate our SaaS security offerings with cloud endpoint telemetry And analytics for better detection and response.

Speaker 2

ThreatSpac also augments our telemetry and virtual security and technology expertise, I want to take this opportunity to once again welcome the entire ThreatSpac team to F5. In closing, We are more confident than ever in our vision and in our ability to continue to execute. The combination of application growth, Our expanded solutions platform, our continuously evolving go to market strategy and our vision for the future of adaptive application It's resonating with customers and puts us at the epicenter of several emerging strong secular trends. I extend my heartfelt thanks to the entire SI's team for their steadfast focus and execution. As a team, we have accomplished more Faster than anyone, even us, thought we could.

Speaker 2

We've got more work ahead, but I am more confident than ever in our ability to achieve our goals. My thanks too to our customers and 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 and A.

Operator

Your first question comes from Sami Badri with Credit Suisse. Your line is open.

Speaker 4

Thank you for giving me a question and you've given us quite

Speaker 3

a bit to Talk about

Speaker 4

on this conference call. I want to shoot the first question over to Frank and I want to talk about the backlog and the backlog composition. And you mentioned The majority of systems based backlog, but I wanted to break down the customer mix of that backlog. If could just tell us a little bit more about what's going on there?

Speaker 3

Jamie, I don't have a lot more to add. I want to say that At the end of the year effectively, we just saw a continued increase in the backlog build more so than we could ship. At the end of Q4, a lot of service provider customers probably fall into that realm. Having said that, it's that was the 125 that you referenced and almost all of it is systems.

Speaker 4

Got it. Got it. And then, Francois, just kind of shifting over to you. I want to talk about the U. S.

Speaker 4

Federal segment And how that made up about 8% of total revenue mix. Are you expecting elevated levels of U. S. Federal activity in the Coming quarters, which would actually be almost out of the seasonal pattern of your model?

Speaker 2

The short answer, Sami, is no. I think what we're seeing in the federal business just follows the regular seasonality that We've seen over the years, and we don't expect a fundamental change to that pattern.

Speaker 4

Got it. Thank you. I'll hand it over to another analyst.

Speaker 2

Thank you, Sami.

Operator

Your next question comes from Meta Marshall with Morgan Stanley.

Speaker 5

Great. Thanks. A couple of questions for me. First on just you obviously did a Couple of instances of Shape Security when of having success when they were facing a threat or there was an entry point where They really needed it, but in the past there have been some delays on proof of concept activity and just wanted to get a sense of it, are you seeing a pickup there? And then on the second point, just on the kind of gross margin impact you're seeing from costs, Is that mostly expediting?

Speaker 5

Is there any ability to pass that on? Just how we should think of the supply chain overhang the gross margins? Thanks.

Speaker 2

Hi, Mira. Thanks for the questions. Let me start on shape. Yes, a couple of quarters ago, we did mention we were seeing the I won't get any time to close on this proof of concept, largely because customers were not in the office And getting those done, we're taking a little longer. We have seen that abate over the last Few months.

Speaker 2

And so we're seeing a pickup in traction and momentum there. And specifically, I think in the e commerce So we've got a number of customers whose applications are revenue generating And they are constantly under these either account takeover attacks or bot attacks that are causing disruption to their business. And so they want to move pretty quickly on getting things done, either as an insurance against future tax or oftentimes when they're under tax, of course, things go very, very quickly Because the business is disrupted. So generally, we are happy with the quarter we just had with Shape. And in general, Mika, I would say, The other thing we're seeing with customers is that the a number of customers have been reevaluating their security posture as The result of some of the high profile breaches that have been well publicized, and that has resulted overall in a very strong Year for the fiscal year for us in security, but especially in the second half where customers have reinvigorated the motion of attaching And we've also seen the momentum with Shape and Security.

Speaker 2

So that's overall the picture we're seeing in Security. As it relates to your second question on gross margins, yes, our gross margins have been impacted by the Challenges on the supply chain, whether it's some increase in prices on some components or Some expedite fees to get our supply when we need it. So the supply chain generally has been Quite a challenging environment. And generally, we have managed that pretty well with our But it continues to be a challenging environment. And so we're going to continue to monitor the developments there And we'll adjust over time as we need to.

Speaker 5

Great. Thank you.

Operator

Your next question comes from James Fish with Piper Sandler.

Speaker 6

Hey, guys. You guys owe Frank a little bit of a raise there after running through all those details. But can you help us a bit understand the amount of recurring software that is term license versus SaaS at this point? As I would suggest, SaaS is actually north of 10% And within that term license piece, while clearly both go together in organic, I guess how specifically should we think about the growth rate of NGINX as we exited

Speaker 3

Yes. Tish, thanks so much for the comments and the questions. I think we have not Split out those 2 components, but what we like to see, which we have continued to see is what it means to have that subscription piece That makes the number that we have to get for the coming year much less as a percent of the software revenue given those dynamics of the Subscription base, the split between what I would say is the term subscription versus the SaaS subscription, we have not Without that yet, but stay tuned. We're continuing to monitor and we'll let you know when that gets substantial. And I'm Sorry, but I missed your second question.

Speaker 6

Just how should we think about the growth of NGINX today exiting?

Speaker 3

Yes. So NGINX continues to grow incredibly well within the base. Again, this quarter we saw from our multiyear Nginx was in more than 50% of those, which is driving great use cases on both sides. And on a customer basis, we continue to see strong growth on the overall customer base within NGINX, obtaining NGINX customers. So really, really happy

Speaker 6

And just quick homework piece for me. ThreatStack, should we think about that as a term license business or a SaaS business?

Speaker 3

That's the SaaS business, but that's ratable.

Speaker 6

Cool. Thank you, guys.

Speaker 3

Thank you, Jim.

Operator

Your next question comes from Rod Hall with Goldman Sachs.

Speaker 7

Great. Thanks for the question, guys. I wanted to just check on the guidance and see whether you guys could give us any idea what you're thinking on systems and software trajectory In Q1? And then I've got a follow-up to that. Thanks.

Speaker 2

Hey, Rod. As you know, we don't guide on a quarterly basis to a breakdown of hardware to software. But I mean, the indicators that I would give you, I mean, you saw the annual guidance for revenue around 8% to 9%. For software, We're guiding to 35% to 40% for the full year and hardware Slightly up. On software in particular, I mean Frank mentioned it, but I want to stress that We guided to 35% to 40% last year for the full year.

Speaker 2

We finished the year at 37%. But inside the year, there was strong variability, especially in the first half. And what we so we still expect to land between 35 to 40. We do expect we will see less variability this year than we saw last year, in part because we have better visibility into a portion of our revenues that are coming from Business that is already contracted, I mean also in part because of the scale of the business. So expect us to land on the range for the full fiscal year.

Speaker 2

We've always said that quarter to quarter there could be some variability above or below that range, but we expect that that variability will be less pronounced.

Speaker 7

Okay. Thanks Francois. And then I guess big picture, I wanted to check the Just your thinking on systems in 'twenty two, when I look at 'eighteen, 'nineteen and 'twenty, all 3 years in systems are down, 'twenty was down 10%. And then you grew systems 12% in 'twenty one. And I recognize you're saying flat to Slightly down, but sort of I'm thinking flattish in 2022, but what gives you confidence that 2021 wasn't We've seen that across a lot of different infrastructure companies that we cover, where they've seen a lot of demand in 'twenty one.

Speaker 7

I think people are extrapolating that into 'twenty two, but why is 'twenty one not a more of an anomaly than it is A new normal for you, I guess. Thanks.

Speaker 2

Yes. And Rod, from our perspective, When we look at so our revenue grew 12% in 2021 And our demand was even stronger than that because we ended up with backlog, large backlog at the end of the year. So when we look at that demand in 2021, some of it actually we think is I wouldn't call it an anomaly, but we think some of it are transient factors that will go away. We think there was some element of a catch up demand because demand was quite depressed 12 months ago. And there also may have been a couple of Earlier in the year when we announced our end of software development, some customers jumped on that to refresh quickly.

Speaker 2

So we think some of these are one of factors, but we also think that there are macro factors that are not transient and that will proceed. And that's specifically The traffic and usage of traditional application is growing and is going to continue to grow Because these applications are generating more revenue, more customer loyalty and more large companies depend on these applications. And so when you look at 2021, there's some element that's one off, there's elements that are not. When we look at that and project to the future, All of that tells us that the demand for big IP as a franchise, so both hardware and software, if you take that combination, we feel today that the demand for BIG IP in the future, even beyond 2022, Will be better than what we would have said a year ago. Now what will be the mix between big IP hardware and software In the future, it's still tough to predict because a lot of it depends on individual customer situations and when they're ready to migrate to software And when they're not, but if you take the combination of those two things, we certainly feel better about it today than we did 12 months ago and that's because of factors But are not an anomaly.

Speaker 2

Those are factors that are kind of secular forces that will continue on.

Speaker 7

Great. Okay, Francois. Appreciate it. Thanks for the time.

Speaker 2

Thank you, Ron.

Operator

Your next question comes from Tim Woollong with Barclays.

Speaker 8

Thank you. Yes, two questions if I could as well. First, maybe you guys mentioned Could you just give us an update on kind of what you guys are seeing on some of those larger term deals as As it goes to usage, traffic growth, things like that, I think they were running ahead. So any color you can give us on TruForce and what that means for your visibility into next year. And then second, thanks for the update on overall security.

Speaker 8

At the Analyst Day, you also gave us I'll look into the cloud verticals. So I'm just wondering if you could kind of update us on how that cloud vertical performed in

Speaker 2

So

Speaker 3

on the TruForce, but we weren't specific. I will say though that the data that we saw this Quarter was actually better than what we saw in Q3. I have to preference that by it's a small Group of customers that have hit their 2nd term in their multi year subscription agreements with us. But we saw a fairly healthy step up between that initial term and the second term and so that's all very quite positive. And then in terms of the TruForward expansions within the terms for those customers, that's a growing customer base.

Speaker 3

Again, that was a bit higher than where we were last quarter. I can't say that that's going to absolutely continue, but we're very, very optimistic by The progress that we've seen in the data that we've gotten so far today.

Speaker 2

So Tim, on your second question, just to clarify, when you said the cloud vertical, so when we talked about our cloud revenue At Analyst Day, we're talking about F5 solutions being deployed in public cloud environment very So in that number, which at the time we said was greater than $100,000,000 we do not include a lot of the business we do with Hi, hyperscalers, SaaS providers, cloud providers, where we are in their infrastructure and helping them deliver applications. So that's all but I'll with that Definitely clarified. Our cloud number continues to grow. As you know, it's 100% software, of course, And it has grown faster than our overall software growth rate, continued this year. And where we are seeing a lot of traction in the In the last 12 months is in what we call private offers on marketplaces.

Speaker 2

And so essentially, That is consumed as a utility by large enterprises. And it is increasingly the case that large enterprises have spent commitments spend commitment on F5, and we've seen an acceleration of that trend. And it's yet another way That we are removing friction in the consumption of F5 software in public cloud, and we're getting the benefit of that in terms of growth. The other big area of growth, Tim, in public cloud is NGINX. A number of the NGINX deployments continue to happen In public cloud, in cloud native environment, and we are seeing in NGINX, I think as I've shared before, When you step back and you look at the success of the BIG IP franchise over the last 20 years, one of the things that We did well with that BIG IP consolidated a lot of functionality initially low balancing, but then security authentication encryption You know, on a single platform and that made things operationally much simpler for our customers and that created the big IT franchise.

Speaker 2

And we're essentially seeing the emergence of the same playbook with NGINX, both on prem and in public cloud environment, The full modern application and the type of application security and delivery that we do in modern app It's not necessarily exactly the same. There are things like ingress controllers, people feel that they have to secure or They need to encrypt their traffic inside their service mesh, so we offer that as well. And of course, we offer security and protection. But when you take that suite of application security and delivery services, we're seeing that playbook Growth for NGINX and that's also one of the factors of growth in public cloud for FIs.

Speaker 8

Okay. Thank you. That's great.

Operator

Your next question comes from Samik Chatterjee with JPMorgan.

Speaker 9

Thanks for taking my question. Pranshu, I guess, I just wanted to ask you on the out your targets you have for 2025, you're already delivering 8% to 9% is your target for next year, that's above horizon 2. How you're thinking about kind of progress from here? Does the tax rate be moved towards the 2025 targets Double digit growth, do you see this kind of setting up a base where you get to those targets faster than you expected? The reason I'm asking is, I guess, with all the enterprise IT companies talking about strong demand, we often get the question from investors of how much of this Strength is really secular versus maybe in some parts cyclical and driven by investment cycle from the enterprise customers.

Speaker 9

So Just trying to get a better kind of how you're thinking about how this sets up for the out years?

Speaker 10

And I have a follow-up. Thank you.

Speaker 2

Yes. Thank you, Samik. Of course, there is quite a bit of Between now and 2025. But here's I think the way We look at it, Samik. I think when you look back at where we were 12 months ago at our Analyst Day and we talked About a long term target of getting to double digit revenue growth.

Speaker 2

We didn't put a year on it, but We felt that we wanted to get to that long term target. By looking back at where we're at today, I would say the things that we thought will help us out around growth in SaaS and security, growth with NGINX And our new value proposition, that's going roughly per plan or per the view that we had at the time. What is showing better is overall the demand for Baking IP. And I think In that going better, there's an element of it that is more of a secular trend that will go on for several years. And so that's kind of the mix.

Speaker 2

Now if you step back from it, Samik, what we are seeing is 3 or 4 years ago, There was a view of the world that say all apps are going to go to a public cloud, and that's kind of the future of the world. I'm sure you're seeing from a number of industry data points, including cloud providers actually saying that themselves that the reality for large enterprises For the last many decades, they have always been told that they just have to get to the next thing and everything is going to go to the next thing. And the practical reality of that is it hasn't happened, right? And there's a realization now that it's not about the next thing, It's about managing a heterogeneous environment and being able to run applications in on prem environment, in public cloud, Increasingly at the edge in colocation environment and enterprises are very comfortable that that's going to be the reality and the conversation Has shifted not to how do I get to a single public cloud in the future, but more of an architectural conversation around, okay, I'm going to be in all these places. What is the simplest way?

Speaker 2

Because that creates complexity for me. What is the simplest way in which I can manage and run my applications across this hybrid environment? And those conversations like F5 has spent like 5 years positioning ourselves to this environment and we're having a lot of joy because we're able to support We feel that that's going to be a secular trend that's going to last for several years. So that's what we're positioning for, Sandvik, and that's Well, generally, we feel good about the next few years.

Speaker 9

First of all, just to follow-up there in terms of positioning the company, and you talked about

Speaker 2

Well, First of all, we have, you know, as I think I said before that we, you know, we did 3, Acquisitions in quick succession, it's pretty substantial acquisition between Shape EngineX and Volterra. And so when we acquired Volterra, we felt that we needed to really focus on the completing integrations of You know, shape at NGINX and Volterra in that period, and we're well on our way of doing that. And I think that's going to we continue to be focused on that On those organic integrations and extensions and now ThreatStack brings a very interesting new capability to F5 in giving us visibility Into these cloud environments and being able to observe the environments in which cloud workloads are running, which complements very nicely the rest of our security portfolio, which as you can see is 100% focused on application security and essentially building the broadest portfolio and application security stack. So that's been the focus. In terms of potential future M and A, over time, we'll continue to evaluate Building versus buying, you've heard me say before, we're very disciplined about that.

Speaker 2

We start always with our preferences to But if for time to market reasons or there's an opportunity to do something that accelerates our vision, then we look at that. The focus of that will continue to be on fulfilling this vision for adaptive applications, which is essentially about the world of Running applications for large enterprises is still very manual, you know, Fought with complexity and fraught with fragility. And we have an architectural vision that we think is going to bring way more automation to this world, You know, way better uptime for applications, way stronger security, and way better intelligence and insights about the performance of applications. And that's what we will focus on, on bringing that vision to our customers, bringing it to reality. And every single quarter, Organically or inorganically down the road, we are making that vision more and more of a reality and it's I think elevating F5 to more of a strategic partner for our customers' digital transformation rather than a point solution

Operator

comes from Alex Henderson with Needham.

Speaker 11

Thank you very much. So I was hoping you could talk a little bit about now that the fiscal year What the transition between last year and this year in terms of market share for Ingenix looks like? It Looks to me like you picked up substantial share over the course of the year. Can you talk about that a little bit? My guess You're up around 65% to 67% market share.

Speaker 11

Is that accurate within Kubernetes workloads?

Speaker 12

Hi, Alex, it's Kara. So we have we're very happy with what we're seeing in terms of the adoption of NGINX. Now, Francois mentioned that NGINX Plays a variety of roles in an application. For example, one thing that is commonly reported is the use NGINX as a web server, and it is true that we have overtaken Apache. NGINX is the number one leading web server.

Speaker 12

There's other uses like reverse proxy, See NGINX used as an API gateway and API management capability NGINX used now increasingly as a workload Protection capability and in those areas there's less reporting on shares. And so at least the one that has very regularly been reported and we see consistent gains is the web server piece and we're very happy with the outcome there.

Speaker 11

Okay. And could you talk a little bit about the degree to which you're able to identify The number of coders that are working with your technology and to what extent there's a growth rate or a Rate of adoption among the coating community, can you talk about your outreach there and to what extent that that's one of the key Building blocks as we go forward?

Speaker 12

Yes. So we've always had a very active community of engaged individuals around F5 Technologies. Even if you go and you look at our capability in BIG IP, given it was one of the most programmable proxy solutions available in the market, We had a very active community of contributors who were sharing iRULES based solutions and are actively contributing and continue to We contribute to our developer community. Now that community has grown even further as we extended our portfolio with NGINX. As you know, just given NGINX has an open it's an open core model and the NGINX open source attracts a wide variety of developers that use that as a fundamental technology for their solutions.

Speaker 12

That's an additional expansion of the developer community around that. And as we look ahead, as we're expanding our portfolio and looking into building what Francois talked about with the Voltera offering, We expect that to continue to be a very important part of our technology and our strategic direction as appealing to developers and providing them the tools they need to deliver excellent digital experiences.

Speaker 11

So no quantification, though?

Speaker 12

No quantification at this time.

Speaker 11

Okay. If I could Slide 1, last one in then. Can you talk a little bit about competition between Cloudflare, Akamai and other players In that space? Thanks.

Speaker 2

Yes, Alex. So we are for the most part, I would say we don't compete very directly with Cloudflare. That's Not a significant overlap today. I think that will grow more as we introduce Our Voltera platform to wide distribution post the integration, because we will play way more at the edge with SaaS security offerings for a wide range of customers. We do Akamai, specifically with Shape Security in the protecting customers against spot attacks.

Speaker 2

And I think their approach is to bundle security with their CDN, especially for customers that are using their CDN. We have an approach that's more about best in class efficacy for enterprise customers that Place significant premium on having world class efficacy against border tax, And we do very well with that customer segment. So we're starting to see more and more competition with these players. And I think As a disruptor with our universal edge platform, that competition is going to grow. We feel very good about the attributes of Volterra.

Speaker 2

And when you combine these attributes that as an edge universal platform and you put there the best in class security stack that FI provides from shape, from big IP. Yes, I think you have a formidable offering for customers that want to consume security as a service at the edge. I think that's going to be a best in class offering.

Operator

Your next question comes from Paul Silverstein with Cowen.

Speaker 13

Thank you for squeezing me in. And I'm going to Assume and hope I'm the last one, so I could ask my 5 questions. But on a serious note, Francois and Frank, I'll apologize if you all have already answered these questions Because you all talk faster than I can listen. So with that big lineup, first off, with respect to the operating margin rebound that you all have referenced in the past, Can you all give us any insight on the glide path considering the significant supply chain challenges that you face Everybody else in the industry and before you respond since it's on the same topic, if I heard you correctly, the 8% to 9% of your revenue guidance you provided for fiscal 'twenty two, What are the supply chain assumptions with respect to that growth rate? What assumptions are you making underlying that?

Speaker 13

And finally, also related, can you address I assume your visibility is that 8% to 9% visibility in general has improved as increasing number of customers have provided you with longer term Cass, I just would like to confirm that that is in fact the case that this boy has been continuing to improve if in fact customers are providing this longer term Thanks so much.

Speaker 3

Yes, Paul. So let me start with your second question, I guess, first. So in terms of What we think about for our outlook on the 8% to 9% in supply chain, as we said in the prepared remarks, It does not anticipate a materially better outlook in terms of our supply chain, Able to get components able for everything else. And so we are assuming that we are looking at That 8% to 9% on what we believe we can ship and what we believe the demand will be for those products. In terms of the specific operating margin expansion, as you recall, we had a 32% to 34% range that we tightened up 32% to 33% largely driven by the gross margin hits that we have been seeing and We expect to see because of some of those supply chain constraints through FY 2022.

Speaker 3

And so we are increasing obviously the efficiencies that Seeing in the business by lifting that up from where we ended at that 31.6%. So at the midpoint almost 100 basis points increase, But we're doing that on the backs of having higher cost on the gross margin side. So actually, there's been some more efficiencies coming through the operating margin.

Speaker 13

And on the visibility question, and Frank, just to be clear, if the supply chain improves, does that translate to better than 8% to 9%?

Speaker 3

It could, but I don't anticipate that from what we see right now, Paul. I mean, again, we're early in Q1, so anything is Well, but what we've seen, obviously, all of the things that we've been reading from the other vendors Collectively, I don't think people are seeing a material starting to see some improvement in the back half of FY 'twenty two calendar, Which is our Q4 obviously, so it doesn't leave us a ton of room to catch up.

Speaker 13

It has visibly improved because of long term forecasting from customers?

Speaker 3

The visibility on demand, I think, has improved. I think the visibility on supply has not. And so matching those 2 up with long lead times, It's hard to say that you catch up within a reasonable period of time.

Speaker 13

I appreciate the responses. Thanks so much.

Operator

Due to time constraints, we'll be taking our last question from Fahad Najam with MKM Partners.

Speaker 10

Thank you for squeezing me in. I Just one clarification, your fiscal 2022 revenue guidance assumes $50,000,000 of revenue contribution from Transact. And am I correct that, that is almost all entirely software recurring in Asia?

Speaker 3

Yes, 15, just to be clear. You broke up for a second there, Fot.

Speaker 10

Okay. So the question is, if we exclude the TrexStack acquisition, then you would hypothetically not Have roughly 50% of your revenue coming from software, given the strength that you're seeing in systems. So one, do you so it's kind of like undershooting your targets as you laid out at the Analyst Day. Is there like something that you see there is a slowdown in terms of organic software growth? I'm just trying to understand how because I think at the Analyst Day, you had highlighted that you would expect to achieve roughly 50% of If your revenue greater than 50% of your revenue coming from software.

Speaker 10

So if fiscal 2021 is kind of 47%, if my math is right, And you would expect significant acceleration in software in fiscal 2022. So just trying to understand what would change in software adoption going forward That hasn't yet happened in fiscal 2021?

Speaker 2

Yes. No, Fahab, thank you. Like, Okay. To be clear, we are in fact hitting our targets that we laid out our aim. So we said 35% to 40%.

Speaker 2

We did 37% this year, And we guided to 35% to 40% next year. Whether or not we exit next year at a mix between hardware and software that is 50% or more of software. We I think we will get there eventually because the trajectory on software is one of growth. And we Over time, we don't think hardware will be an engine of growth. But frankly, if we don't hit that target, largely because our hardware has totally over performed, we will be very happy And not just happy because of what's going on in the short term, but happy because what it translates to is, A, that the BIG IP franchise overall is doing better than we thought and B, all these Customers that are extending that time, purchasing hardware and not making a transition to software, it creates a bigger installed base For us to migrate to software down the road.

Speaker 2

So it actually is very good news over time, even for our software business, because we have a much bigger real estate. So we're the what we're focused on, of course, is If you look at it in absolute dollars, we will absolutely hit the target that we gave for Software revenue for the 5 in Horizon 2. If those absolute dollars translate to 50% mix, That's fine.

Speaker 6

If they don't

Speaker 2

because hardware has over performed, we'll be happy with that.

Speaker 3

And Fahd, it just is It bears stating what we said before. We said our entry rate was 50%. That would be the equivalent of the 45% of what we just did in Q4. And so The trajectory is absolutely heading in that direction. And stay tuned, it's Q1.

Speaker 10

Yes. And actually, just To kind of follow-up on that. So to your longer term targets circa 'twenty five, it seems like your Business is actually projecting faster towards software growth given the strength in hardware. I think I'm just trying to make sure that I'm understanding it correctly that maybe there is actually fundamental improvement beyond further from what was laid out at the It seems like the longer term targets are probably going to be better than what was laid out. But again, as you've mentioned, it's early days, but just trying to understand

Speaker 3

I just would point to the obvious, but we just did over 10% total growth in the about the trajectory of the business that we've been seeing. We talked specifically about FY 'twenty two guidance, more to come on the long term target updates. But Our focus is really on ending Horizon 2 at or above any of the expectations that we At our Analyst and Investor Day as well as what we updated after the Voltaire acquisition.

Speaker 10

Appreciate the answers. Thank you.

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Earnings Conference Call
F5 Q4 2021
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