F5 Q1 2022 Earnings Call Transcript

Quartr
Provided by Quartr
January 25, 2022

There are 12 speakers on the call.

Operator

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 speakers' presentation, there will be a question and answer session. Also, today's conference is being recorded. If anyone has an objection, please disconnect at this time.

Operator

I'll now turn the call over to Ms. Suzanne Dulong. Ma'am, you may begin.

Speaker 1

Hello, and welcome. I'm Suzanne Doolong, F5's Vice President of Investor Relations Francois Le Cordonu, 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 A copy of today's press release is available on our website at f5 .com, where an archived version of today's call will be available through April 26, 2022.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.

Speaker 1

To access the replay of today's call by phone, dial 800-585-8367-4416 621-4642 and use meeting ID 6,879,935. 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 f.dulongfi.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. Our strong Q1 results demonstrate our customers' need to grow and evolve the applications that support and drive their businesses. Customer demand stay in our portfolio, driving 10% revenue growth in Q1 and our 5th consecutive quarter Double digit revenue growth. Underpinning our top line growth is robust 47% software growth, 1% systems growth and 2% global services growth in the quarter.

Speaker 2

In fact, both software and systems demand Exceeded our expectations in Q1, contributing to our outperformance. 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 all of us in the industry, since late 2020, we have been taking progressively more aggressive steps to manage supply chain risk.

Speaker 2

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 continued to grow in Q1. Over the last 30 days, suppliers of critical components that span a number of our platforms We have informed us of significant increases in decommits, these get in the form of both order delivery delays And sudden and pronounced production in shipment quantities, the step function decline in component availability The challenge is achieved in Q2 and we expect Q2 revenue in the range of $610,000,000 to $650,000,000 as a result. This revenue range reflects a $60,000,000 to $80,000,000 shortfall in our ability to ship in our Q2 versus what we would have expected Supply chain limitations are likely to have a net $30,000,000 to $90,000,000 impact to our prior revenue guidance for fiscal year 2022.

Speaker 2

We are aggressively working to mitigate the impact of 2 primary gaming supply challenges in neotherm. 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. 2nd, we also have experienced significant recommit We are working to design and qualify the pricing 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 We can mitigate the impact on the second half of our fiscal year.

Speaker 2

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 Let me be very clear. Demand 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, We did not change the significant opportunity we have to solve our customers' most critical application security and delivery challenge, No need to change our longer term growth potential. Our software transition continues to gain momentum.

Speaker 2

In fact, We now expect to be closer to the top end of our 35% to 40% software 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 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.

Speaker 2

Our Q1 customer wins offer great insights to both our momentum and the opportunity ahead. For instance, pervasive application security threats like Log 4 j 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 AppDefense To add WAF protection closer to the containers deployed by a DevOps feed. This is in addition to the advanced WAF We also see growing demand for fraud and bot defense.

Speaker 2

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 the game's persistent automated attacks. Shape dramatically reduced the customers' automated traffic, Successfully reducing the tune of 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.

Speaker 2

As a result, they need infrastructure that Sales are automatically to meet user demands or down to save cloud costs. For instance, during Q1, An American multinational investment bank and financial services customer selected NGINX to help modernize their Kubernetes application. 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 to help them solve an escalating volume of application security and delivery challenges and multi cloud challenges and modern app challenges like These challenges and the complexity they entail are only mounting for our customers.

Speaker 2

They see F5 as an innovator uniquely equipped to help them build and scale both their traditional and modern application environment. And the cloud ready capabilities we are building with our Voltera and QuestPack integrations only enhance our positioning and appeal. I'll now turn the call to Frank to review our Q1 results and our outlook. Frank?

Speaker 3

Thank you, Francois, and good afternoon, everyone. I'll review our Q1 results before providing our Q2 outlook and updated fiscal year 2020 As Francois outlined, our team delivered another very strong Q1. 1st quarter revenue of 687,000,000 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 $343,000,000 It's up 19% year over year, representing 50% of total revenue.

Speaker 3

Q1 software revenue grew 47% to 163,000,000 representing 47% of product revenue, up from 38% in the year ago period. Systems revenue of $180,000,000 is up 1% compared to Q1 last year. Rounding out our revenue picture, we see continued strength from our global services With $344,000,000 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 revenues 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.

Speaker 3

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 68% of revenue in the quarter. On a regional basis in Q1, Americas delivered 17% revenue growth year over 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 In the quarter, service providers represented 15% and government customers represented 14%, including 4% from U. S.

Speaker 3

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 related to our supply chain in the next several quarters.

Speaker 3

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 438,000,000 Non GAAP operating expenses were $345,000,000 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%.

Speaker 3

GAAP net income for the quarter was $93,600,001.51 per share. Non GAAP net income was $179,000,000 or $2.89 per share. I will now turn to the balance sheet. We generated $90,000,000 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.

Speaker 3

Q1's cash flow is below our recent range because of 2 primary factors. First, We had strong multiyear subscription sales in the quarter. As a reminder, our multiyear subscriptions are generally sold on 3 year terms. We built only 1 third of the contract at signing with the remainder going to unbilled assets. 2nd, During the quarter, we also had some significant prepayments with our contract manufacturer associated with the components for future builds.

Speaker 3

DSO for the quarter remained strong at 55 days. Cash and investments totaled approximately $936,000,000 at quarter end. During the quarter, we repurchased approximately $125,000,000 worth of F5 shares or approximately 539,000 shares at an average price of $2.32 Capital expenditures for the quarter were $11,000,000 Deferred revenue increased 16% year over year to $1,576,000,000 up from $1,359,000,000 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 ThreatStack acquisition, which closed in the quarter.

Speaker 3

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 Let me start with Q2. We expect Q2 revenue in the range of $610,000,000 to $650,000,000 as a result of supply chain related systems production constraints. Taking into account continued component cost increases and the costs related to actions we are taking to mitigate supply chain pressures, We expect Q2 gross margins of approximately 82% to 82.5%.

Speaker 3

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 not intend to adjust our operating model. 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 $357,000,000 to $371,000,000 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 percent Q1 tax rate with some fluctuations quarter to quarter, our Q2 earnings target is 1.75 to $2.15 per share.

Speaker 3

We expect Q2 share based compensation expense of approximately $65,000,000 to 67,000,000 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 $30,000,000 to $90,000,000 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 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.

Speaker 3

Like other vendors, we have seen component costs 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 1, 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 2022 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 of 40 operating benchmark, where the combination of our revenue growth and non GAAP operating margins total 40. We also remain committed to repurchasing 500,000,000 in shares during the fiscal year. With that, I will turn the call back over to Francois.

Speaker 3

Francois?

Speaker 2

Thank you, Frank. In closing, I'll note that we are making very good progress with our Vocera and Threattback integration, And you will be hearing more about our results in SaaS based solution offering very soon. We remain 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 And our imminently launching software as a service app security and delivery solution. While we are sorely disappointed that supply chain challenges have Given 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.

Speaker 2

Our Q2 pipeline is strong, and we have good visibility into demand for the back half of our fiscal year. Our customers are faced with ever increasing performance expectations for their applications, while at the same time scaling to meet unprecedented demand and evolving their architectures to enable production scale and innovate infrastructures. With our adaptive application vision and Our ability to serve any app anywhere, F5 brings cloud ready solutions that close the gap between customers' traditional and modern application environment. Finally, I extend my heartfelt thanks to the entire F5 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.

Speaker 2

With that, operator, We will open the call to Q and A.

Operator

For our first question, we have James Fish from Piper Sandler. James, your line is open.

Speaker 4

Hey, guys. Obviously, after hours getting a lot on the supply chain stuff and a number of your networking System peers took careful measures to ensure supplies and mitigate the commits. Why is this now impacting F5? Or why wasn't it done 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?

Speaker 2

Hi, Jim, it's Francois, and I'll take your first question. I so Let me just start from the last point in your question, and I'll come back to the supply issue. On the demand side, 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. In Q1, If you're referring specifically to hardware, you saw that our hardware revenue was pretty much flat, But our backlog continued to grow in our 1st fiscal quarter.

Speaker 2

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.

Speaker 2

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 our the issue with our supply chain has deteriorated steadily. And last year, we were not able to shift to 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 A number of components.

Speaker 2

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 relook at The view for the year and see that we wouldn't be able to even ship the systems that we have planned to ship for the full year. To just give you a sense, Jim, the number of decommits, so we're now seeing over 400 decommits for quarter and we were running about 30% less than that even just a month ago. So we are the situation is quite unprecedented. We are doing a number of things to mitigate These supply issues working with our suppliers, of course, on escalations and Allocations of supply to F5, we will be working on shifting some of our demand to we've introduced new hardware platforms that are Forms that are just starting to ship recently and utilize more readily available components. So we'll be working to shift some of the demand we have to these newer hardware platforms.

Speaker 2

And we have a number of mitigation elements in place to improve the situation, but The other thing that has changed in the last 30 days relative to where we were before is that we We have been going to not just our suppliers, but also when we couldn't get the supply, we have been going to secondary markets. So on the open market through brokers to get part of our supply and that avenue has dried up 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.

Speaker 4

That's amazing color, Francois. And keeping on

Speaker 5

the supply chain stuff as

Speaker 4

a follow-up, I mean, How much of the supply capacity are we now at given the commitments, but also it sounds like new arrangements with suppliers? In addition, you guys talked about a mitigation timeframe for the fiscal second half. So does this

Speaker 5

mean we should expect upside to kind of

Speaker 4

fiscal 'twenty three for where we're at? Or is there a risk

Speaker 2

Thanks, Jim. Let me just make sure. So We don't see any risk to orders being canceled. The demand we have is very real. Our lead times Unfortunately, we have gotten progressively worse over the last 5, 6 quarters, but we haven't seen any change In the you know, any increase in order cancellation and we don't expect to see that going forward.

Speaker 2

In terms of the timing of improvement, Jim, I want to clarify because there are 2 issues really at And I want to make sure I give you visibility into both issues. So let me talk first about our fiscal year. So the $30,000,000 to $90,000,000 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 chipset. The lack of supply of those is really what's driving that $30,000,000 to $90,000,000 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 at 5 and we would start to be able to ramp up our levels of shipment.

Speaker 2

So that's The situation that is affecting the full year. As it relates specifically to our Q2 in Q2, we have an additional challenge, Which is more standard electronic components, where we have had a significant disconnect 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 chipset That will take several quarters before we see meaningful improvement there.

Operator

For our next question, we have Sami Badri from Credit Suisse. Sami, your line is open.

Speaker 6

Hi, thank

Speaker 3

you. First, Francois and maybe Frank,

Speaker 6

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 because 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 about what's happening, Right. That could service, for example, what they had in mind.

Speaker 6

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. Thank you. That would be great.

Speaker 2

Thank you, Sandy. I'll start with the second part of the question, then we'll go to software. I'll start the software answer and then Frank may add to it. So Sami, 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.

Speaker 2

Historically, our lead times were 2 weeks or less. They're absolutely world class. And I mean that sort of You know, pre, 2021. As our lead times got worse in 2021, they extended to 4 to 5 weeks. And I would say for the last several quarters, we've been in that kind of 5 week zone.

Speaker 2

For orders that are placed to date By customers, the lead times have extended, but they are going to be in the range of 6 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 done, They're still in the zone of kind of 4 to 4.5 months at the high end, Which you can check with other vendors around the industry in our space and you'll find that those lease times Don't stand out as being worse than anybody else. And I think our customers have adjusted to having longer planning cycles for the environment that they're building. So we are not seeing customers as a result of extended lead times Start to completely rethink their architectures. I think if our lead times were to become 12 months or more, We would see a much different behavior, but we don't see that and we don't expect that even with The challenges that we're having at the moment shipping to customers.

Speaker 2

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 3 drivers of growth in software You know, as part of our strategy, are essentially all going to plan. So let me start with the first part. So the 3 drivers are what?

Speaker 2

It's driving growth in traditional applications to software first and multi cloud environment second, scaling our modern application franchise And 3rd, security. So let me unpack these 3 drivers for you, Sami. So the first one, we have seen Broad based strength in enterprise for software for BIG IP, specifically, I would 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 1st quarters of the pandemic, we're seeing more of those customers moving With their migration to software first architectures, even for traditional applications. So that is helping with seeing very strong second terms renewal and true forwards for our multiyear subscription agreements.

Speaker 2

So all of that is contributing to strength in traditional applications growth in software. The second aspect is order and 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 The average size of deals increased 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.

Speaker 2

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 Net Ops team still have this complexity to deal with The networking and security challenges for Kubernetes are very different than what they've done in a more traditional environment, and NGINX It's really the ideal complement to Kubernetes to address these challenges. And so we're seeing a lot of traction with this deployment. And the 3rd 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.

Speaker 2

We saw strength in BIG IP. We're seeing more customers That 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 the 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 anti bot and API security as a bundle.

Speaker 2

We continue to see growth in NGINX security. And then Shape, Shape had a strong quarter. We had the Probably our best quarter in terms of new logo acquisition. We started to see broader based adoption in new Turning 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.

Speaker 2

We completed the Integration of Shape into salesforce.comecommerceplatform, 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 look at across All three drivers of software, we really had strong momentum and strong execution and we're really pleased with where we are on software.

Speaker 6

Got it. Thank you.

Operator

For our next question, we have Amit Dharbiani from Evercore. Amit, your line is open.

Speaker 5

Thank you for taking my question. I have 2 as well. First off, I'm hoping You just helped me reconcile the March quarter fiscal year guidance. And Francois, I thought I heard you talk about the 2 different component challenges that you have. But your March quarter guide, I think if I take it at midpoint implies in the first half, you'll grow 3.7% or so.

Speaker 5

But then for you to hedge a full year guide, it almost implies that you have to grow high single digits in the back half of the year, June September. So Am I doing this correctly? And I guess, why the confidence that Google snapped back so quickly in the June, September quarter for you folks?

Speaker 3

Sure. I mean, why don't I start with that one and then see if Francois has anything to add. So I think Francois, I'll try to articulate The difference of the near term challenges we're having in Q2 and some of those acute standard components that 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 not 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 catch up on that in Q3 and Q4.

Speaker 3

And so That's what gives us confidence that Q2 is the low mark. When you take the combination of the 2 quarters that you just said, yes, 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.

Speaker 2

Got it.

Speaker 5

Perfect. And then, I guess the second one, and this almost seems silly to ask in all the hard questions we have. But on the software side, and You talked a fair bit about it, but you did 47% growth on probably one of the more difficult compares. I think it was 70% last year.

Speaker 2

And your guide sort of right now with

Speaker 5

the full year would imply that your software growth will decelerate as your compare starts 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 you talked about that, doesn't

Speaker 2

Amit, 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 Q1. 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.

Speaker 2

But it's too early to be Changing that view for now and what you should take away from our sense is that We really like what we're on software, and we think it's going to be a very good software year.

Speaker 5

Fair enough. And best of luck. Thanks for the time.

Speaker 2

Thank you, Amit. Thanks, Nik.

Operator

For our next question, we have Alex Henderson from Needham. Alex, your line is open. Thanks, Sandy. So I wanted

Speaker 7

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. Switching prices are up double digit and they're forcing people into these subscription 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.

Speaker 7

So can you address what you're hearing from The C suite on those thoughts about changing their behavior in a more exciting fashion.

Speaker 2

Hi, Alex. So I would first, I would say, Alex, we know we are going through an extraordinary situation as it relates to supply. Everybody along the value chain is feeling that and you're seeing different type of behaviors. In some case, you are seeing some suppliers in the semiconductor space who are taking advantage of that to To some extent, Gauge on prices. And that we believe is a short term Approach that may have some benefits, but in the long term, it's detrimental to relationships.

Speaker 2

And so the way we look at it is Our customers and our shareholders are going to be happy if we continue to have great long term relationships with our customers And continue to be with them as they evolve their architectures. And so as we think about how do we balance the cost pressures with price increases, We are looking at it through the lens of also 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 Our customers are seeing things in our conversations. Of course, They want to get their products as fast as possible.

Speaker 2

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 like for like 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 Supplies to them faster, but we're not seeing a dramatic change in their behavior 2 or the 5 from what we saw through last year.

Speaker 7

If I could follow-up on a separate question, 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 A shift to software and security that you've shifted away resources away from them. Can you talk about To what extent you're shifting away from intentionally shifting away from that space in favor of your higher growth alternative areas?

Speaker 2

Alex, I would not say that we are intentionally shifting away from the service provider space. We had a very strong Through the last 5, 6 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 has actually been growing very healthily over the last several quarters, including this last quarter. And so and also with what we're seeing coming in the 4 gs to 5 gs transition, We see strong opportunities both in hardware and software with service providers with some potentially important deals to come over the next few quarters.

Speaker 2

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.

Speaker 3

And Alex, just as a reminder that 15 percentage Bookings not of revenue, and certainly not a total revenue. So, as proxy, you can get about it in relation to product revenue, but that's what it's In relation to.

Speaker 2

Thanks. Thank you, Alex.

Operator

For our next question, we have Rod Hall from Goldman Sachs. Rod, your line is open.

Speaker 8

Yes. Hey, guys. Thanks for the question. I wanted to start by clarifying the backlog number. I I think, Francois, you'd said it grew just over 10%.

Speaker 8

And I think you guys had called out $125,000,000 of backlog last quarter or so. Is it right to think that that backlog is in the ballpark of $140,000,000 this quarter?

Speaker 3

Lot, it's in the ballpark for the Systems side, what Francois was referencing was the systems piece of the backlog, which as we said, NRK was the vast majority of that 125, but I just

Speaker 2

Okay.

Speaker 8

So just shave a little something off the $125,000,000 and up by $10,000,000 plus and that puts us In the ballpark. Okay. Thanks, Frank. That's helpful. And then I wanted to just kind of ask a bigger picture question.

Speaker 8

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 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 $12,000,000 or $13,000,000 from your midpoint of your $35,000,000 to $40,000,000 to $40,000,000 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 why the software is not going up more to compensate for the hardware weakness.

Speaker 2

Well, great question. So I first want to remind you, well, that Where there is an opportunity to substitute, if you will, hardware for software is really in our BIG IP platform. But the drivers of software growth are across the entire portfolio. So that's The first thing you got to remember. 2nd, when you say, hey, why is there not more substitution in the IP of hardware for software?

Speaker 2

The first reason is because hardware demand is not weak. So the hardware 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 We see security existing security customers even extend Verified's security footprint in hardware. And generally, application growth, Traditional application growth continues and therefore our hardware demand to support those applications continues to be very strong.

Speaker 2

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 You know, 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.

Speaker 2

First of all, F5 is not the only consideration that they have. There are other vendors that are part of their environment That drives that architectural decision. And second, I think our lead times would have to really extend well beyond 6 months So just a lead time factor to cause our customers to really change and look at software. Now With all of that being said, with the supply challenges that we're having, our teams when working with customers, if The 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.

Speaker 2

But we don't look to that as a thing that's going to shift multiple tens of 1,000,000 of dollars from one consumption factor to the other.

Speaker 8

Great. Okay, Francois. I really appreciate all that color. Thank you.

Speaker 2

Thank you, Rod.

Operator

For our next question, we have Mira Marshall from Morgan Stanley. Mira, your line is open.

Speaker 9

Great. Thank you. I was just wanting to get a sense, you noted kind of the shortages you're seeing are 2 pronged, both on the specialized chips and the more standardized components. Just wanted to get a sense of, is the deterioration you saw more severe in kind of one or the other in the quarter? And just What guidance kind of implies a top bottom

Speaker 6

of the range? Does one have

Speaker 9

to improve more than the other to kind of achieve those? And then maybe just a second question for me. We've seen a lot of the networking peers kind of build inventory pretty significantly or tend to build Inventories pretty significantly over the course of the last year. This is going forward, getting out of this, has this kind of changed

Speaker 2

Yes, Meta. Just a couple of let me start with the last part of your question. So we have been Buying components with extraordinarily long lead times, some of the components that were decommitted at the very Beginning of this calendar year for us were components that we had ordered more than 52 weeks ago. We have Several 100 components today that have more than 2 years lead time. So we have been getting ahead of this for the last 18 months And making very strong advanced buys in anticipation of issues, getting commitments from suppliers that in some cases After 52 weeks of waiting, I'm 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.

Speaker 2

And so 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 2 issues we are seeing? I think there are really 2 dynamics, Meta. The first issue, which is The specialized networking chipsets from the large kind of specialized chip manufacturers, That issue is going to take a while to get better. It is about wafer capacity And more capacity coming online for us to get the parts that we need to have ultimately and that's going to take several quarters.

Speaker 2

And in our the range of 30 to 90 that we have assumed, to be very clear, We have assumed that in there the potential for more to commit 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 today. So that's kind of the 30 to 90 range. And to get closer to the 30,000,000 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 components, this really is It's to do with the timing of the specific ticket for a couple of parts. That is really unfortunate for parts That we had on order for a very long time.

Speaker 2

And The timing of that we commit makes it such that we can't we qualify the other parts and design around it and be able to ship in quarter. We will requalify. 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.

Speaker 9

Got it. Thanks.

Operator

For our next question, we have Sameet Chatterjee from JPMorgan. Sameet, your line is open.

Speaker 10

Hi. Yes. Thanks for taking my question. I guess, if I just start with the non supply question here. I think, Francois, you mentioned that there's no change in How you think about the business longer term, you're not changing your operating model here, given some of the temporary issue You're seeing here you reiterated buying back about $500,000,000 of the stock.

Speaker 10

What's the inclination Nor what's the appetite to maybe aggressively do a bit more on the buyback given that the outlook for the business longer term hasn't changed, but this temporary setback obviously

Speaker 3

Sure, Sumit. So let me start with that one. We talked about the $500,000,000 of share repurchase maybe more ratably throughout the course of the year. We've established automatically repurchase programs associated with that. And so I'm not going to get into the In's and out to the execution of that program, but it is we haven't changed the level of commitment that we intend to make.

Speaker 3

It's still $500,000,000 when exactly that triggers. TBD as we see how the stock plays out, But we do not anticipate moving that program up from $500,000,000 because we want to stay balanced on the Strategic reasons why we entered into that kind of balance in the first place.

Speaker 10

Okay. Got it. And just a follow-up on Where you've talked particularly last year about the true forwards that you will kind of 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?

Speaker 10

I think in general, as we look In terms of your software guide, I think to an earlier question, it does imply some moderation growth, which I think is more of you Just waiting for execution, but is there an impact there on the true forwards being more weighted to 1 half of certain half of the year?

Speaker 3

So the Truforwards, 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 new with a second And those were more weighted in the back half.

Speaker 10

Okay, good. Thank you.

Speaker 2

Thank you, Samik.

Operator

Due to time constraint, we will take our last Question from Paul Silverstein from Cowen. Paul, your line is open.

Speaker 11

I appreciate you all squeezing me in and I appreciate all the Questions in response to some supply chain. So I apologize that I've got yet another. And perhaps this should be clear already, but I just want to make sure I understand what you're saying. If the $30,000,000 to $90,000,000 if I understand you correctly, if the $30,000,000 to $90,000,000 shortfall relative Your original 90 day ago expectation for fiscal 2022 is all related to the specialized When those new files would come online hasn't changed over that 90 day period, you didn't expect to benefit From those coming online earlier than what you now expect, what changed with the decommissioning from your current suppliers in the specialized or the Current available chipsets. Is that correct?

Speaker 2

Yes. Both assertions are correct, Paul.

Speaker 11

All right. Francois, 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 and if they're not shifting to your competitors, Is it a given that your backlog will increase by $30,000,000 to $90,000,000 whatever the ultimate shortfall Relative to your 90 day ago expectation. That's just basic math, isn't it?

Speaker 2

Pretty much. I mean, it's It's forecasting backlog exactly is we're probably not going to do that. But yes, our backlog will increase by multiple tens of 1,000,000 of dollars Starting this quarter, of course, in Q2, but even for the full year, yes, we expect our

Speaker 11

If I could squeeze in one more, I'm going to apologize again if you're starting to clear, but Given that you're almost a full month into the quarter, why the significant Range in the guidance for the quarter, isn't it just that the visibility and confidence as to additional to commence, it's Just not it's sparse, for lack of a better way to put it. What accounts for that dramatic a range in the near term? I You've only got 2 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?

Speaker 2

Paul, that's a great question. 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 $20,000,000 and the range is twice that for two reasons. And they're both related to life. The first reason, Paul, is that this We commit we've had on the standard component. Our teams are sort of working 20 fourseven So we qualify, find alternative parts and be able to solve some of that in quarter.

Speaker 2

And so that's but we don't know yet if we're going to be able to do all of that kind of design work And get that to manufacturing and be able to ship these parts before the end of March, sorry, these products before the end of March to customers. So there is an added uncertainty that comes from that. And then the second part of that And then the second part of that uncertainty is also in quarter, we are looking to shift Some of the demand to the newer platforms that are more readily available and how fast we can ramp those platforms, there's also Some uncertainty associated with that. So those are the 2 elements of supply that could go one way or the other that add a little more Uncertainty to the call and this is why you see the range. But I want to be very clear, both are related to supply.

Speaker 2

They're not related to some worries we would have about demand. And the reason We, of course, are working 24, like Solomon to do this. It's because ultimately, our North Star is getting products to our customers. And we understand that the lead times are extended for them and we want to be able to satisfy the demand as fast as possible for customers that are waiting on this and for their applications that are growing. So that's our North Star, but that explains the range, Paul.

Speaker 11

I appreciate the responses.

Operator

And ladies and gentlemen, this concludes today's call. You may now disconnect.

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Earnings Conference Call
F5 Q1 2022
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